By Paul A. Merriman, MarketWatch
When we’re faced with the task of financial planning, one of the hard parts is projecting a reasonably probable future return for our investments.
We have tons of information about the past, but we can’t know the future. So what can we count on, anyway?
Like lots of other things in life, the future of investment returns must remain somewhat a mystery.
Still, I believe the past contains valuable lessons of what’s reasonable to expect. The world’s climate may be evolving, but you still know that at least for the foreseeable future, the tropics will be hotter than Northern Canada and that summer will be warmer than winter.
Similarly, if you think about the people you know, really good souls are likely to remain so, and jerks are not likely to quickly become nice people.
These things let us plan our lives around probability instead of leaving our comfort and our friendships entirely to chance.
Likewise, I believe some long-established investment patterns are likely to persist, for the same reasons they have persisted so far.
I believe investors can use these patterns to significantly improve their returns, without taking much additional risk or straying far beyond their current comfort levels.
Small changes…think of the trim tab on the rudder of a ship…can produce big results. Without getting into the mechanics of trim tabs, which are used in aircraft and boats of all sizes, I want to quote Buckminister Fuller from an article he wrote in the February 1972 issue of Playboy magazine.
“Think of the Queen Mary—the whole ship goes by and then comes the rudder. And there’s a tiny thing at the edge of the rudder called a trim tab.
“It’s a miniature rudder. Just moving the little trim tab builds a low pressure that pulls the rudder around. Takes almost no effort at all.”
Fuller used the metaphor to argue that just one person can make a huge difference by being a trim tab. I’ll use the trim tab metaphor to argue that even a small change in investment return can make a huge difference over a lifetime.
Imagine this simple scenario: Starting at age 25, you and your twin sister each invest $5,000 and continue doing so once a year for 40 years. Your out-of-pocket savings total $200,000 apiece.
When you’re 65, you each start withdrawing 4% of your portfolio value at the start of each year, and you continue that for 30 years.
Now imagine that you achieve a compound return of 8% a year up to age 65 and a return of 6% after that. Your sister, however, has a pre-65 return of 8.5% and an after-65 return of 6.5%.
The difference is a “mere” one-half of 1%. In any given year, you and your sister would barely notice the difference.
But on your joint 65th birthday, you would have $1.4 million and your sister $1.6 million. Hmmm. That difference is equal to the total of all the money each of you put into your savings.
And that’s just the start of it.