Research summary

Four timeless principles for investing success

November 30, 2023

The words investing success can mean different things to different people. Being clear on what success means is key to mapping out a plan to help achieve it.

Although investing can seem perplexing and complex, success is largely within one’s control. Having a tailored investment strategy can go a long way to reducing the stress and noise associated with investment decisions. In our research paper, Vanguard’s Principles for Investment Success, we offer four investing principles designed to help investors focus on what’s important to them and give them the best chance for investment success.

Create clear, appropriate investment goals

There is no one-size-fits-all plan for reaching financial objectives. Goals are unique to an investor’s situation, preferences, and aspirations. Identifying and prioritizing financial intentions allows investors to focus on what matters most, in an order that works for them. It also helps them decide where they’re willing to compromise.

Once investors set and prioritize goals, they can figure out how much—and for how long—they’ll need to save. The value any portfolio achieves over time is the sum of two elements: savings (the amount an investor puts into their portfolio) and investment returns. Much of the discussion about investment success tends to focus on investment returns, but both elements are crucial in reaching a goal. Time is a key factor here. For short time horizons, savings—which is within an investor’s control—is the driving force in achieving an investment goal. As the time horizon increases, investment returns increase in importance.

Savings and investment returns both contribute to the achievement of any investment goal

Over any given goal horizon, an investment balance is the sum of savings (the amount an investor puts into the investment portfolio) plus the investment returns on the total amount invested.

Chart shows the changing proportions of savings and investment returns in contributing to an investment goal over time. The y-axis of the chart is labeled “Portion of contribution to investment goal,” with “0%” on the bottom and “100%” on the top. The x-axis is labeled “Goal horizon (years)” and runs from zero on the left to “40” on the right, with “2,” “10,” and “30” called out in between. A general arc is shown in the chart, running from the bottom of the lower left side to a little above the midpoint of the right side (at roughly 65%). Pale blue and teal define this arc, with pale blue representing savings and teal representing investment returns. The chart shows that as the goal horizon increases, the contribution to the goal amount from savings diminishes and the contribution to the goal from investment returns increases. Three sets of data are called out along the arc, for the 2-, 10-, and 30-year points along the x-axis, showing the proportion of savings and investment returns at each point. At two years, the contribution proportions are 94% savings, 6% investment returns; at 10 years, they are 80% savings, 20% investment returns; at 30 years, they are 51% savings, 49% investment returns.

Notes: The calculation for the contribution of savings and investment returns is as follows: Assuming a 4% real return (after inflation), we calculate how much an investor needs to invest annually to achieve a given investment goal for different time horizons, varying from 0 years (now) to 40 years. Savings represent the amount invested (the principal). Contributions are assumed to be the same every year relative to the year investing begins.

Source: Vanguard.

Keep a balanced and diversified mix of investments

Stocks are risky, but so is avoiding them. Stocks are more volatile in the short run, but historically they’ve outperformed cash-equivalent assets in the long run. By spreading investments across stocks and bonds and among sectors and countries, an investor can reduce overall portfolio volatility while also safeguarding against unnecessarily large losses.

An appropriate asset allocation takes into account an investor’s risk tolerance—how much volatility they can tolerate in their portfolio—and risk capacity—their ability to withstand a loss in their portfolio (a reflection of their time horizon and cash flow needs). Factoring in an investor’s time horizon and their tolerance for risk can lead to a tailored portfolio that’s suitable to personalized situations.

Minimize costs

Market movements and financial returns are hard to predict, but costs are often controllable. The two broad types of costs that investors can minimize are (1) taxes and (2) investment costs, which include expense ratios, transaction costs, and sales charges. Together, these costs cut into investment returns, sometimes significantly. To reduce these expenditures, and help improve returns, an investor can:

  • Seek out lower-cost funds. The evidence is clear: Lower-cost mutual funds have historically outperformed higher-cost mutual funds after costs.1
  • Implement tax-advantaged and tax-efficient investment strategies, where available. These strategies might include retirement account options, reducing transaction activity, and having a strategic plan for tax-efficient asset location.
Maintain perspective and long-term discipline

Discipline in investing is the ability to adhere, over time, to an investment plan. It’s natural to want to react to market volatility, but acting on that emotion can lead to an impulsive decision, like panic selling during an unstable market. Taking a long-term perspective can help an investor maintain discipline and avoid a potentially harmful emotional move.

The importance of maintaining discipline: Reacting to market volatility can jeopardize returns

What if investors shifted to cash at the bottom of the COVID downturn and stayed there until the market recovered?

Line chart shows the importance of maintaining discipline during volatile market events, using the Covid-19 market drawdown of 2020 as a case study. The y-axis represents the portfolio return, running from –10% on the bottom to 50% on the top. The x-axis represents time, running from January 2018 through October 2022. A single teal line plots the returns for a 60/40 stock/bond portfolio from the start of the period to March 2020, at which point the single line diverges into two lines for the rest of the period: A teal line that plots the post-March 2020 portfolio returns where the investor kept the 60/40 allocation, and a brown line that plots post-March 2020 portfolio returns where the investor fled to cash from March 18, 2020 through July 28, 2020. The brown line is markedly lower than the teal line. Three pieces of callout text are shown. On the upper left, one piece of text runs next to an arrow pointing to where the line diverges; it reads “COVID downturn: What if investors moved to 100% cash from the bottom of the market in March 2020 until the recovery in July 2020?” To the right, callout text summarizes the ending portfolio return for each of the two paths. The top callout reads “21% return for investors who kept 60%/40% stock/bond allocation.” The bottom callout reads “–2% return for investors who fled to cash from March 18, 2020, through July 28, 2020.”

Notes: Stocks are represented by the MSCI All Country World Index; bonds are represented by the Bloomberg Global Aggregate Bond Index (USD Hedged). Cash is represented by the Bloomberg U.S. Treasury 1–3 Month U.S. Treasury Bill Index. Returns are in nominal terms.

Sources: Vanguard calculations, using data from Morningstar, Inc.

Past performance is no guarantee of future returns. The performance of an index is not an exact representation of any particular investment, as you cannot invest directly in an index.

Staying the course can help increase an investor’s chance of success, but so can other actions, like making regular contributions to a portfolio, and increasing them over time.  

Other actions that can increase the likelihood of reaching an investment goal? A consistent plan to rebalance a portfolio, a disciplined spending strategy, and a regularly scheduled date to monitor and review goals.

Our four principles can help investors focus on the aspects within their control, so they can build tailored plans to help them achieve investing success.

1 Lawrence, Stephen, and Jan-Carl Plagge, 2023. The Case for Low-Cost Index-Fund Investing. Vanguard research.

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Note:

All investing is subject to risk, including the possible loss of the money you invest.

Diversification does not ensure a profit or protect against a loss. There is no guarantee that any particular asset allocation or mix of funds will meet your investment objectives or provide you with a given level of income.

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