As an investor, there is an endless list of metrics you are told to track: the P/E ratio, debt, cash flow, expense ratios, anniversaries, birthdays, shopping lists, etc. But there is one metric that matters more at first than any of the above: your own savings rate. Why?
It's the difference between absolute and percentage changes.
It won't matter much if you can earn 10% a year on your savings if you have none. It's much more important, at first, to build up that savings in order for your return rate to a have a meaningful effect.
A mathematical look
When choosing an index fund, it's important to pay attention to expense ratios. For example, the Vanguard S&P 500 ETF's (NYSEMKT: VOO ) expense ratio of 0.05% beats the SPDR S&P 500 (NYSEMKT: SPY ) ETF's net expenses of 0.095%. If you invested $500 into both funds, after a year, that difference in expense ratios would amount to a little more than $2.
However, if you focused on saving an additional $500 to invest, rather than on minute expense ratio differences, even the more expensive SPDR would leave you with hundreds more (beyond that initial extra $500) after just a few years:
|Year||Vanguard S&P 500 ETF||SPDR S&P 500
After five years, that extra $500 of savings generated $220 extra in value. The amount of money you invest means much more than a tiny difference in fees.
Starting out with a larger investment isn't easy, but as you juggle the importance of expense ratios -- and all the other metrics you might pore over as you determine your portfolio, don't forget that the most important factor is having the most capital available to invest. And this starts before you even think about which stocks or funds to invest in.
Save first, worry about maximizing returns second
Unless a meaningful amount is invested, even an outstanding percentage return means little. The time you spend working hard to return 10% on $100 might have been better spent bringing lunch from home for a few days. As you build up your savings and investments, even the 0.045% difference in the Vanguard and SPDR ETFs' expense ratios will become material and worth worrying about.
But first, grow that base of savings.
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