Financial Knowledge is Key to Maximizing Long-Term Savings
Submitted by RDM Capital on March 6th, 2015A recent study by the National Bureau of Economic Research indicates that a key component of investment success over the long-term is financial knowledge, as outlined recently in CNN Money. Specifically, participants in the study were asked basic questions to test their financial literacy. The study found that those participants with the most financial knowledge had over 1% greater returns annually on average than those participants with the least financial knowledge. As we have written in this blog in the past, even a 1% difference in returns can make a significant difference over the long-term when the compounding of returns is considered.
An important explanatory factor in the difference of returns is the greater allocation of funds by successful investors to equities. While there have been relatively brief periods of time in history when bonds have outperformed equities, over the long-term returns from equities historically have greatly outpaced returns from bonds. For example, as discussed in the CNN Money article, whereas $100 invested in 1928 in treasury bonds would lead to $6,972 in wealth in 2014, the same amount of money invested in equities would lead to a balance of $289,995 in 2014.
The downside to investing in equities, as many who invested during the most recent financial crisis can attest, is volatility. Many investors let the fear of market volatility or another market downturn cause them to under-invest in equities and over-invest in bonds or other perceived "safe" investments, which leads to less wealth accumulation over the long term. This is why it is very important to establish an appropriate asset allocation taking into consideration an investor's risk tolerance and financial needs over various time horizons. For longer time horizons, it is usually most appropriate to emphasize equities, however, bonds may be more appropriate for short-term needs to preserve capital. Ultimately, it is important for investors to rely on an independent fiduciary advisor like RDM Capital for financial education and creation of an asset allocation that works for the investors' needs in order to achieve long-term financial success.
