Relative Importance of Savings Rate, Asset Allocation, and Investment Selection

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TD2626
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Relative Importance of Savings Rate, Asset Allocation, and Investment Selection

Post by TD2626 » Fri Oct 06, 2017 10:38 pm

I have been wondering the answer to this question:

What percentage of the average Boglehead investor's success is due to having a high savings rate and living below one's means?
What percentage of the average Boglehead investor's success is attributable to stock/bond/cash asset allocation?
What percentage of the average Boglehead investor's success is attributable to investment selection?

I think that the overwhelming majority of one's results would be dictated by savings rate and asset allocation. Things which S&P 500 fund to use or whether to include international bonds are of comparatively minor importance, even though these get a lot of attention.

Is there a good way to ascribe percentages to this effect, though?

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Re: Relative Importance of Savings Rate, Asset Allocation, and Investment Selection

Post by livesoft » Fri Oct 06, 2017 11:06 pm

What do you mean by "success"? I've been around long enough to know that people will have the allocation they want because that's what they want. So someone will feel successful with a 30% stock allocation and someone else will feel successful with a 90% stock allocation and someone else will feel successful with no bonds and just cash and so on.

And here are two numbers: 4.86% and 4.44%. They are the past 10-year average annual growth rate of two funds. The 0.42% difference is pretty small and might be attributed to difference in expense ratio or taxes or something else. One is Vanguard LifeStrategy Moderate Growth and one is LifeStrategy Conservative Growth. One can say the asset allocation is different, but not that important.

As far as investment selection goes, you might look at multi-asset (balanced, target date) funds from various fund sponsors over the long-term. Their rate of return will tell you about fund selection versus asset allocation, right?
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Re: Relative Importance of Savings Rate, Asset Allocation, and Investment Selection

Post by dbr » Sat Oct 07, 2017 8:41 am

TD2626 wrote:
Fri Oct 06, 2017 10:38 pm
I have been wondering the answer to this question:

What percentage of the average Boglehead investor's success is due to having a high savings rate and living below one's means?

If you don't live beneath your means you can't save and if you can't save you can't invest. On the other hand, there are people with money who inherited it or who liquidated a business. I don't have data on which is which here, but it does seem there are few posters here who don't have money and/or don't intend to have money somehow.

What percentage of the average Boglehead investor's success is attributable to stock/bond/cash asset allocation?

As livesoft says success is in the eye of the beholder. But there are people who realize they were too conservative and did not build the wealth they might have and there are posters who confess to taking too much risk and behaving badly to their detriment. I have no idea what the data would be on that.


What percentage of the average Boglehead investor's success is attributable to investment selection?

If by investment selection you mean investing in low cost funds that don't produce really bad results due to bad active management decisions, I would say the issue is significant. Trying to put a percentage on that is not to be had. There are lots of posters here losing huge amounts of money due to foolish engagement with advisors selling bad products.

I think that the overwhelming majority of one's results would be dictated by savings rate and asset allocation. Things which S&P 500 fund to use or whether to include international bonds are of comparatively minor importance, even though these get a lot of attention.

A comment sometimes made here is that the more a topic is discussed the less it actually matters.


Is there a good way to ascribe percentages to this effect, though?

No, you are not going to get numbers assigned to this.

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Re: Relative Importance of Savings Rate, Asset Allocation, and Investment Selection

Post by sambb » Sat Oct 07, 2017 9:14 am

savings rate and asset allocation >>> expense ratio
However discussions about expense ratio >> savings rate often times.

I would much rather have a higher savings rate, and an appropriate risk asset allocation, with funds with a higher expense ratio, rather than vanguard funds, but with a low savings rate.
Last edited by sambb on Sat Oct 07, 2017 9:16 am, edited 1 time in total.

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Re: Relative Importance of Savings Rate, Asset Allocation, and Investment Selection

Post by DaleMaley » Sat Oct 07, 2017 9:15 am

I think the question of impact of asset allocation versus investment selection has already been answered many years ago. A famous study was done, the researcher's name escapes me, where he looked at the return of large pension funds. If I remember right, 90% of the pension fund's return was determined by the funds asset allocation.........not the selection of investments and not market timing. A typical Boglehead focuses on asset allocation and uses low cost index funds to implement the desired AA.

So if you accept the results of that study, then the question comes down to savings rate and asset allocation. One wild card that upsets the apple cart is the ability of an investor to "stay the course" every time we have a bad stock market period (which has occurred about every 8 years on average since WWII). If someone buys high and sells low in a panic, the portfolio return suffers dramatically, compared to staying the course.
Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. – Warren Buffett

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Re: Relative Importance of Savings Rate, Asset Allocation, and Investment Selection

Post by DaleMaley » Sat Oct 07, 2017 10:05 am

Brinson was the name I was trying to remember.........

Asset allocation relies on the notion that different asset classes offer returns that are not perfectly correlated and diversifying portfolios across asset classes will help to optimize risk-adjusted returns. The topic went largely unexplored until 1986, when Gary P. Brinson, CFA, Randolph Hood, and Gilbert L. Beebower (known collectively as BHB) sought to explain the effects of asset allocation policy on pension plan returns. In their seminal paper, “Determinants of Portfolio Performance,” published in the Financial Analysts Journal, BHB asserted that asset allocation is the primary determinant of a portfolio’s return variability, with security selection and market timing (together, active management) playing minor roles. BHB’s 1986 study examined the quarterly returns of 91 large U.S. pension funds over the 1974 to 1983 period, comparing the returns to those of a hypothetical fund holding the same average asset allocation in indexed investments. A linear time-series regression yielded an average R-squared of 93.6%, leading BHB to conclude that asset allocation explained 93.6% of the variation in a portfolio’s quarterly returns.

more on it https://blogs.cfainstitute.org/investor ... llocation/.........
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Re: Relative Importance of Savings Rate, Asset Allocation, and Investment Selection

Post by livesoft » Sat Oct 07, 2017 10:12 am

"[R]eturn variability" is NOT the actual return. So that Brinson study is often misquoted that asset allocation sets return. Asset allocation sets how much one's return varies over time: "variation in a portfolio's quarterly returns." Clearly, 100% cash should have a very low variation quarter-to-quarter, while 100% stocks has a high variation, but stocks can still have a lower return than cash.

I'm not sure where/when the misquoting started, but I suspect it was from a non-mathematical journalist reporting on the paper or perhaps something appeared in marketing material for an investment management firm.
Last edited by livesoft on Sat Oct 07, 2017 10:23 am, edited 1 time in total.
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Re: Relative Importance of Savings Rate, Asset Allocation, and Investment Selection

Post by ThriftyPhD » Sat Oct 07, 2017 10:17 am

The percentages are going to change based on what life stage you're at. First few years of work, your saving rate and LBYM are probably the biggest driver of growth. As your assets grow and your earnings start to outpace your investments, your choice of AA would start to matter more. As you retire, the expense ratio on your investments can have a big impact on your safe withdrawal rate; 4% safe withdrawal becomes 3% if you have a 1% AUM fee.

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Re: Relative Importance of Savings Rate, Asset Allocation, and Investment Selection

Post by TD2626 » Sat Oct 07, 2017 1:25 pm

livesoft wrote:
Fri Oct 06, 2017 11:06 pm
And here are two numbers: 4.86% and 4.44%. They are the past 10-year average annual growth rate of two funds. The 0.42% difference is pretty small and might be attributed to difference in expense ratio or taxes or something else. One is Vanguard LifeStrategy Moderate Growth and one is LifeStrategy Conservative Growth. One can say the asset allocation is different, but not that important.
By the way, I got that Moderate Growth's 10 year return was 4.96% and Conservative Growth was 4.51% (See https://personal.vanguard.com/us/funds/ ... 0914#tab=0 and https://personal.vanguard.com/us/funds/ ... undId=0724)

For a hypothetical investor, say their "ideal" allocation was a complicated factor-based portfolio that would have returned (making up a number for the sake of debate) 5.1%.

From this, saving, LBYM, and putting the money in a reasonable, conservative fund got the investor 4.51% out of the 5.1% ideal CAGR. Thus, savings rate got the investor 4.51/5.1 = ~88% (0.8843)

Thinking about asset allocation, carefully considering risks and fund options, etc could have gotten the investor 4.96% instead. Having the new AA and LBYM got the investor 4.96/5.1=97% of the way there. Thus the total attributable to the change in AA was 97%-88% = 9%.

The other 3% of the results in this case would be due to to investment selection. Investment selection is a herculean if not impossible task: it is very, very difficult if not impossible to know in advance specific funds best.

So if this illustration is reasonable and if I did the math right, 88% of results would be from savings rate, 9% from asset allocation, and 3% from investment selection. Just one (very hypothetical) example.

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Re: Relative Importance of Savings Rate, Asset Allocation, and Investment Selection

Post by livesoft » Sat Oct 07, 2017 1:34 pm

The returns from Vanguard are legit, but for a different date range than I used from morningstar.com.

Both LifeStrategy funds use the same funds, so their difference in return cannot be attributed to investment selection which is as you see. You might compare VSMGX, VBIAX, and DGSIX to see how different funds fare for the same asset allocation. You should also find an actively-managed 60/40 fund from a poor manager like Ameriprise or Edward Jones. But then are you comparing expense ratios instead?

Vanguard itself has this white paper about some things that affect returns, too: https://www.vanguard.com/pdf/ISGQVAA.pdf This paper has a few renditions at vanguard.com I used "advisor alpha" as my search term and you can find the other versions with the same search term.
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Re: Relative Importance of Savings Rate, Asset Allocation, and Investment Selection

Post by Sandtrap » Sat Oct 07, 2017 3:27 pm

TD2626 wrote:
Fri Oct 06, 2017 10:38 pm
I have been wondering the answer to this question:

What percentage of the average Boglehead investor's success is due to having a high savings rate and living below one's means?
100%. There would be nothing to invest otherwise. First things first. You have to make money and save it before considering doing anything with it.
What percentage of the average Boglehead investor's success is attributable to stock/bond/cash asset allocation?
100% maximizing the gains from earning and saving and living below one's means.
What percentage of the average Boglehead investor's success is attributable to investment selection?

I think that the overwhelming majority of one's results would be dictated by savings rate and asset allocation. Things which S&P 500 fund to use or whether to include international bonds are of comparatively minor importance, even though these get a lot of attention.

Is there a good way to ascribe percentages to this effect, though?
It makes sense to focus on maximizing one's income streams and savings rate during the accumulation phase.
Make this a priority and the other factors fall into place . . . . . with the help of the Bogleheads. :D

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Re: Relative Importance of Savings Rate, Asset Allocation, and Investment Selection

Post by WanderingDoc » Sat Oct 07, 2017 3:39 pm

TD2626 wrote:
Fri Oct 06, 2017 10:38 pm
I have been wondering the answer to this question:

What percentage of the average Boglehead investor's success is due to having a high savings rate and living below one's means?
What percentage of the average Boglehead investor's success is attributable to stock/bond/cash asset allocation?
What percentage of the average Boglehead investor's success is attributable to investment selection?

I think that the overwhelming majority of one's results would be dictated by savings rate and asset allocation. Things which S&P 500 fund to use or whether to include international bonds are of comparatively minor importance, even though these get a lot of attention.

Is there a good way to ascribe percentages to this effect, though?
People will probably tell you savings rate is more important, I just don't see it. Personally, I have never saved nor had a budget. I have earned a 7-figure real estate portfolio in only a few years (3-5). I would estimate my savings rate at <<10% during this time. I went out of my way to travel and try new restaurants every other day. I suppose if you want to take ALL of your savings and let the stock market do its thing, it would matter more. Good luck.

I would say you #3 "investment selection" is paramount. It is more important to do the right thing (ie. investment vehicle and selection), rather than doing things right.
One day it suddenly dawned on me that I had won the real estate lottery. | I'm not looking to get rich quickly. I'm not looking to get rich slowly. I'm looking to get rich for sure.

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Re: Relative Importance of Savings Rate, Asset Allocation, and Investment Selection

Post by Grt2bOutdoors » Sat Oct 07, 2017 3:43 pm

WanderingDoc wrote:
Sat Oct 07, 2017 3:39 pm
TD2626 wrote:
Fri Oct 06, 2017 10:38 pm
I have been wondering the answer to this question:

What percentage of the average Boglehead investor's success is due to having a high savings rate and living below one's means?
What percentage of the average Boglehead investor's success is attributable to stock/bond/cash asset allocation?
What percentage of the average Boglehead investor's success is attributable to investment selection?

I think that the overwhelming majority of one's results would be dictated by savings rate and asset allocation. Things which S&P 500 fund to use or whether to include international bonds are of comparatively minor importance, even though these get a lot of attention.

Is there a good way to ascribe percentages to this effect, though?
People will probably tell you savings rate is more important, I just don't see it. Personally, I have never saved nor had a budget. I have earned a 7-figure real estate portfolio in only a few years (3-5). I would estimate my savings rate at <<10% during this time. I went out of my way to travel and try new restaurants every other day. I suppose if you want to take ALL of your savings and let the stock market do its thing, it would matter more. Good luck.
You don't see it because your "luck" is clouding your judgement. Had you not amassed a 7 figure real estate portfolio is 3-5 years you would be singing a much different tune. You used leverage and it worked out for you, in life the dice will rarely roll with favorable results ALL of the time.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

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Re: Relative Importance of Savings Rate, Asset Allocation, and Investment Selection

Post by WanderingDoc » Sat Oct 07, 2017 3:49 pm

Grt2bOutdoors wrote:
Sat Oct 07, 2017 3:43 pm
WanderingDoc wrote:
Sat Oct 07, 2017 3:39 pm
TD2626 wrote:
Fri Oct 06, 2017 10:38 pm
I have been wondering the answer to this question:

What percentage of the average Boglehead investor's success is due to having a high savings rate and living below one's means?
What percentage of the average Boglehead investor's success is attributable to stock/bond/cash asset allocation?
What percentage of the average Boglehead investor's success is attributable to investment selection?

I think that the overwhelming majority of one's results would be dictated by savings rate and asset allocation. Things which S&P 500 fund to use or whether to include international bonds are of comparatively minor importance, even though these get a lot of attention.

Is there a good way to ascribe percentages to this effect, though?
People will probably tell you savings rate is more important, I just don't see it. Personally, I have never saved nor had a budget. I have earned a 7-figure real estate portfolio in only a few years (3-5). I would estimate my savings rate at <<10% during this time. I went out of my way to travel and try new restaurants every other day. I suppose if you want to take ALL of your savings and let the stock market do its thing, it would matter more. Good luck.
You don't see it because your "luck" is clouding your judgement. Had you not amassed a 7 figure real estate portfolio is 3-5 years you would be singing a much different tune. You used leverage and it worked out for you, in life the dice will rarely roll with favorable results ALL of the time.
Perhaps. However, whether or not one believes in "luck", is more of a philosophical debate rather than a financial one. I suppose that every successful entrepreneur and investor with a plan got lucky?

Gr8, nice to catch you back on here by the way. Take any cool trips lately? :happy
One day it suddenly dawned on me that I had won the real estate lottery. | I'm not looking to get rich quickly. I'm not looking to get rich slowly. I'm looking to get rich for sure.

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Re: Relative Importance of Savings Rate, Asset Allocation, and Investment Selection

Post by whodidntante » Sat Oct 07, 2017 3:51 pm

How much you save/accumulate is by far the most predictive factor. Asset allocation and fees only matter if there is something for it to matter with.

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Re: Relative Importance of Savings Rate, Asset Allocation, and Investment Selection

Post by Grt2bOutdoors » Sat Oct 07, 2017 4:12 pm

WanderingDoc wrote:
Sat Oct 07, 2017 3:49 pm
Grt2bOutdoors wrote:
Sat Oct 07, 2017 3:43 pm
WanderingDoc wrote:
Sat Oct 07, 2017 3:39 pm
TD2626 wrote:
Fri Oct 06, 2017 10:38 pm
I have been wondering the answer to this question:

What percentage of the average Boglehead investor's success is due to having a high savings rate and living below one's means?
What percentage of the average Boglehead investor's success is attributable to stock/bond/cash asset allocation?
What percentage of the average Boglehead investor's success is attributable to investment selection?

I think that the overwhelming majority of one's results would be dictated by savings rate and asset allocation. Things which S&P 500 fund to use or whether to include international bonds are of comparatively minor importance, even though these get a lot of attention.

Is there a good way to ascribe percentages to this effect, though?
People will probably tell you savings rate is more important, I just don't see it. Personally, I have never saved nor had a budget. I have earned a 7-figure real estate portfolio in only a few years (3-5). I would estimate my savings rate at <<10% during this time. I went out of my way to travel and try new restaurants every other day. I suppose if you want to take ALL of your savings and let the stock market do its thing, it would matter more. Good luck.
You don't see it because your "luck" is clouding your judgement. Had you not amassed a 7 figure real estate portfolio is 3-5 years you would be singing a much different tune. You used leverage and it worked out for you, in life the dice will rarely roll with favorable results ALL of the time.
Perhaps. However, whether or not one believes in "luck", is more of a philosophical debate rather than a financial one. I suppose that every successful entrepreneur and investor with a plan got lucky?
Not all, but many had things for which they had no direct control "roll" their way. You know the saying "luck begets luck".
Gr8, nice to catch you back on here by the way. Take any cool trips lately? :happy
Not lately.
"One should invest based on their need, ability and willingness to take risk - Larry Swedroe" Asking Portfolio Questions

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Re: Relative Importance of Savings Rate, Asset Allocation, and Investment Selection

Post by CyclingDuo » Sat Oct 07, 2017 5:08 pm

TD2626 wrote:
Fri Oct 06, 2017 10:38 pm
I have been wondering the answer to this question:

What percentage of the average Boglehead investor's success is due to having a high savings rate and living below one's means?
What percentage of the average Boglehead investor's success is attributable to stock/bond/cash asset allocation?
What percentage of the average Boglehead investor's success is attributable to investment selection?

I think that the overwhelming majority of one's results would be dictated by savings rate and asset allocation. Things which S&P 500 fund to use or whether to include international bonds are of comparatively minor importance, even though these get a lot of attention.

Is there a good way to ascribe percentages to this effect, though?
They all tie in together, but how about we take a look at one of the most damning portions of the formula that could result in a failure of success?

Fees matter a heck of a lot! In fact, they matter so much that it could impact one's savings rate. How so?

The 2% Rule for Retirement Savings

If you can hold on to most of the 2% per year or so that the average mutual fund and financial advisor skim from their clients annually, you'll only need to save about half as much money for retirement.

http://www.retireearlyhomepage.com/twopercentrule.html

That's right. Get it right and you only have to save half as much money for retirement. Get it wrong with fees and you'll struggle because you will have to save twice as much with those fees skimming money out of your pockets.

This table illustrates in row 1 the low cost fund scenario, row 2 the average mutual fund scenario ER fee plus trading commissions, and row the 3 the highest cost mutual funds + an AUM fee that some pay to show what can happen over various time periods. It's quite frightening, actually...

Image

You can easily see that in row 2 and row 3, your savings rate would have to be twice as much for 40 years (typical length one saves for retirement) to get the returns of the low-cost index fund returns.

How many times have we seen new BH's post up the funds they have available in their employer's plan - be it 401k, 403b, 457, etc... - with high fees in the 1.5% - 2% range?

Get the fee structure right with your investment choices, and average households can be successful with their savings providing they are living within their means and saving. Get the fee structure wrong, and....well the table above shows the results as does the link.

Getting one's hand held here and pointed to, or led in the right direction about all of this is priceless.

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TD2626
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Re: Relative Importance of Savings Rate, Asset Allocation, and Investment Selection

Post by TD2626 » Sat Oct 07, 2017 11:16 pm

CyclingDuo wrote:
Sat Oct 07, 2017 5:08 pm
TD2626 wrote:
Fri Oct 06, 2017 10:38 pm
I have been wondering the answer to this question:

What percentage of the average Boglehead investor's success is due to having a high savings rate and living below one's means?
What percentage of the average Boglehead investor's success is attributable to stock/bond/cash asset allocation?
What percentage of the average Boglehead investor's success is attributable to investment selection?

I think that the overwhelming majority of one's results would be dictated by savings rate and asset allocation. Things which S&P 500 fund to use or whether to include international bonds are of comparatively minor importance, even though these get a lot of attention.

Is there a good way to ascribe percentages to this effect, though?
They all tie in together, but how about we take a look at one of the most damning portions of the formula that could result in a failure of success?

Fees matter a heck of a lot! In fact, they matter so much that it could impact one's savings rate. How so?

The 2% Rule for Retirement Savings

If you can hold on to most of the 2% per year or so that the average mutual fund and financial advisor skim from their clients annually, you'll only need to save about half as much money for retirement.

http://www.retireearlyhomepage.com/twopercentrule.html

That's right. Get it right and you only have to save half as much money for retirement. Get it wrong with fees and you'll struggle because you will have to save twice as much with those fees skimming money out of your pockets.

This table illustrates in row 1 the low cost fund scenario, row 2 the average mutual fund scenario ER fee plus trading commissions, and row the 3 the highest cost mutual funds + an AUM fee that some pay to show what can happen over various time periods. It's quite frightening, actually...

Image

You can easily see that in row 2 and row 3, your savings rate would have to be twice as much for 40 years (typical length one saves for retirement) to get the returns of the low-cost index fund returns.

How many times have we seen new BH's post up the funds they have available in their employer's plan - be it 401k, 403b, 457, etc... - with high fees in the 1.5% - 2% range?

Get the fee structure right with your investment choices, and average households can be successful with their savings providing they are living within their means and saving. Get the fee structure wrong, and....well the table above shows the results as does the link.

Getting one's hand held here and pointed to, or led in the right direction about all of this is priceless.
I absolutely agree that fees are very important, and that 1-2%+ fees are unacceptable. In the 1% or 2% fee case, I think I would count this as an expense, counting against savings rate, the same as groceries or eating at a restaurant. People should calculate how much they number of dollars they are or would be paying in fees and realize that a few percent of their assets year after year after year is awful.

That being said, there is a far bigger difference between a 1% fee and a 0.1% fee vs a 0.1% fee and a 0.01% fee. Yes, both differences are a factor of 10, but the fees in dollars are small either way once one gets below, say, 10 basis points.

When comparing a TSM-type index fund and a small cap index fund or a value index fund, some people may argue that paying a few basis points more in fees may be worth it based on their beliefs regarding factor investing. This sort of fee would in my opinion count against investment selection and not savings rate as it is an inherent cost of a strategy.

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Re: Relative Importance of Savings Rate, Asset Allocation, and Investment Selection

Post by camillus » Sun Oct 08, 2017 12:44 am

Savings Rate is the most important factor in personal finance.

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Re: Relative Importance of Savings Rate, Asset Allocation, and Investment Selection

Post by CyclingDuo » Sun Oct 08, 2017 6:18 am

camillus wrote:
Sun Oct 08, 2017 12:44 am
Savings Rate is the most important factor in personal finance.
True, that! But fees really, really, really matter a lot. If the tail wags the dog, then fees wag the savings rate.

Take the OP's original three questions, and once you get beyond the living within one's means, it could be something simple like:

Fees/Savings Rate
Asset Allocation
Diversification
Stay The Course

Openfolio did a review of 25,000 client portfolios a couple of years ago to determine the most common pitfalls investors need help with (fees, concentrated or risky investments, and mis-allocated cash were the top three that impacted 70.3% of investors in their review):

Image

http://www.businessinsider.com/openfoli ... sis-2015-4

https://openfolio.com/
https://openfolio.com/data/
Last edited by CyclingDuo on Mon Oct 09, 2017 9:58 am, edited 2 times in total.

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Re: Relative Importance of Savings Rate, Asset Allocation, and Investment Selection

Post by midareff » Sun Oct 08, 2017 7:14 am

TD2626 wrote:
Fri Oct 06, 2017 10:38 pm
I have been wondering the answer to this question:

What percentage of the average Boglehead investor's success is due to having a high savings rate and living below one's means?
I would say 80% is due to this. Maybe more.
What percentage of the average Boglehead investor's success is attributable to stock/bond/cash asset allocation?
If we are already a Boglehead, we know there isn't a huge difference in performance between 60/40, 50/50 and 40/60. We also know that if you don't save and live below your means you won't have any money to invest and it won't matter what your AA is. so I would say 15%.
What percentage of the average Boglehead investor's success is attributable to investment selection?
The average Boglehead is already well versed in the three fund portfolio. .. Again, if you don't save and live below your means it doesn't matter what your AA is or what your investment selection is....... maybe 5% here.

I think that the overwhelming majority of one's results would be dictated by savings rate and asset allocation. Things which S&P 500 fund to use or whether to include international bonds are of comparatively minor importance, even though these get a lot of attention.

Is there a good way to ascribe percentages to this effect, though?

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Re: Relative Importance of Savings Rate, Asset Allocation, and Investment Selection

Post by DaleMaley » Mon Oct 09, 2017 8:23 am

I set up a simple spreadsheet to try to assess the relative impact of savings rate, AA, and investment selection upon ending portfolio value at age 65.

I ignore taxes, and I am using long-term stock and bond average returns, so no Monte Carlo usage to simulate annual variation in returns. Here are the inputs:

Image

The expected worse case scenario is to select investments with high expense ratios. These same investments not only have relatively high ER's, they also under-perform the stock or bond market averages over long periods of time.........like the 43 working years from college graduation until retirement at age 65. To simulate this under-performance, I apply a percentage of the index average as an input to the spreadsheet.

Here are the outputs for the Cases I set up......

Image

I expected to find that the savings rate is a much bigger "lever" than the AA............and this is what my crude Excel model shows. I was a little surprised what a big "lever" it is just to switch from high cost active mutual funds that under-perform the market averages........to using low cost index funds.

So my simple study shows that after you become a Boglehead and invest in low-cost index funds, then priority wise focus on increasing your savings rate versus worrying too much about your asset allocation. Pick an asset allocation that lets you sleep at night during bad stock market years, and focus on your savings rate :D :D

You can download my simple Excel model file https://www.dropbox.com/s/otn1e3mv3oet0 ... 7.xls?dl=0

If you download the file, click on the 3 little dots in the upper RH corner to let you download the file. Thanks!
Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. – Warren Buffett

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