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The Spectrum of Control: Long-Term Investing

spectrum of controlThere is one core tenet to my investment philosophy: Focus on important factors that you can control. In the exhibit above, these are the factors in the upper-righthand corner of the chart and include:

  • Your asset allocation: Research suggests that asset allocation explains over 90 percent of performance. This will be an important driver of your long-term investment success, and you have complete control over it.
  • Setting goals: By setting appropriate goals and working toward them, you will vastly improve your chance of success.
  • Cost of investing: Although there will be some cost of investing in funds, this factor is largely within your control and finding reasonably priced funds is critically important to your long-term success. For example, if you invested $250 per month over the course of 30 years, an extra 1% in fees would reduce your end portfolio value by somewhere around 17 percent!
  • Your budget: how much you save is hugely important to how much you end up with in the end. After all, you can’t invest what you don’t save.
  • How you react to markets: Although our human nature compels us to run away after markets have fallen, the better response is actually to stay invested at precisely the time when it hurts the most.
  • Starting early: The control over this factor is largely based on your age, but the power of compounding shows us that starting early is possibly the most important factor to investment success. If you can’t start early, start now!

On the other hand, there are important factors over which we have little control, as shown on the left side of the exhibit and include:

  • Market timing and performance: Consider the fate of two investors who started investing just 10 years apart, one in January 1965 and the other in January 1975. Let’s say that they both saved $500 per month (we’ll ignore inflation, taxes, and fees for simplicity). They both maintained passive portfolios composed of 50 percent stocks and 50 percent U.S. Treasuries. At the end of 20 years, the 1975 investor would have had $476,000, and the 1965 investor would have had $336,000.
  • Tax rates and the economy: Here’s another factor that will play a big role in your investment success that you have little to no control over (although you do have some control over how you allocate your resources for tax efficiency).

You may think that the market will tank because China’s economy is slowing, or that gold will skyrocket in value because inflation is due for a spike, or that bond yields have nowhere to go but up, but the market doesn’t care what you think. You might be right, and you might be wrong. A prepared investor will plan for multiple scenarios and focus on what can be controlled.

Again, you can’t control or predict what the market will do. You should develop a process and a plan for how you will react, or not react, over time. In the spectrum of control, we suggest that you focus on what you can control instead of what you can’t. There’s no use in beating yourself up about missing out on something that happened in the past. What matters now is what happens in the future. The good news is that factors you can control are often more important than the ones you can’t.

Focus on saving as much as you can. Focus on reducing your investment costs. Focus on furthering your career. Focus on controlling your emotional reaction to markets. All of these things are within your control and will help you become a better long-term investor.

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