How to Stack the Odds in Your Favour

Legendary investor Stanley Druckenmiller’s is one of the more vocal bears around. His views are partially driven by the fact that in the beginning of the last secular bull market, multiples were low and interest rates were high. In plain English, stocks had a lot of room to run. Today, we are faced with the exact opposite situation; low rates and high multiples.

Whether or not you agree with Druckenmiller, it makes sense to be conservative when making long-term forecasts. It’s a better idea to prepare for low returns and be surprised than to expect high returns and be disappointed.

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The worst 20-year period saw U.S. stocks compound at just 1.9%. There is no reason to think we can’t experience another long period of  low returns. But the good news for younger investors is that there is an antidote to low returns; higher savings.

The chart below shows a few different scenarios: A portfolio that contributes $5,000 every year that earns 4% and a portfolio that contributes $5,000 a year that earns 6%. It also shows a portfolio that earns 4% and 6%, but raises the contribution by 5% a year. Finally, I’m showing portfolios that earn 4% and 6% but raise the contribution each year by 10%.

Here are a few takeaways:

1. Compounding your money for 20 years at 4% wouldn’t be spectacular.  However, seeing your money grow 119% is not so terrible either.
2. Saving more money can offset lower returns because you’re compounding on top of compounding. Look at the red line versus the green line for instance. Earning 4% and raising your contribution by 10% will leave you $100,000 richer than earning 6% and raising your contribution by only 5%.
3. A 401(k) is a great way to juice your returns. You can literally double your money with an employer match. Using round numbers as an example, an employee earning $100,000 contributing 5% can sock away $5,000 and get a 100% return on their money if the employer matches that contribution. Oh yea, those tax deferrals aren’t bad either.
4. The chart above is a simple visual, but just because U.S. stock market might deliver low returns, does not necessarily mean an investor will earn those same low returns. With bi-weekly contributions, an investor has the ability to enhance their returns by potentially adding to stocks at opportune times.

It’s entirely possible that stocks might have below average returns for the next few decades. And while future returns are out of our hands, the choices we make today are entirely in our control. Save more and spend less is the best way to stack the odds in your favor.