The Power of 2% Outperformance
September 29, 2021
Estimated Reading Time: 6 minutes
The Compounding Effects of a 2% Advantage
Over an investor’s lifetime, small percentage differences have a profound impact on wealth. Einstein speaks to this power in his famous quote, stating “compound interest is the 8th wonder of the world. He who understands it, earns it; he who doesn’t, pays it.”
The intelligent investor - one who can harness a small outperformance over time - fares considerably better in matters of wealth than his fellow, non-optimized investors. On an account worth $1,000,000, an investor averaging a 0.5% greater return over 25 years would earn more than $500,000 more that their counterpart. This example of a small-percent outperformance, while seemingly nominal, speaks to the benefits of a wealth management strategy focused on optimizing the small details to realize significant results.
This article focuses on the 2% advantage - a small, achievable, sustainable outperformance over the duration of an investor’s lifetime. We’ll see the difference in a 2% outperformance over the lifetime of an investor and present strategies an investor can use to realize this outperformance advantage, going beyond the investments in their portfolio to optimize their entire financial picture. For the savvy investor, the investment to gain a 2% outperformance over time pays more than dividends in its return.
To illustrate the power of a 2% advantage over time, we will use the hypothetical scenario of an investor with an account of $1,000,000. Given the annualized S&P performance since 1957 has been 8% and that most investors take a balanced approach to investing, we will use a 6% annualized return for the investor diversified between equity and fixed income.
Over 25 years, an investor annualizing a 6% return will have an ending balance of $4,291,871. Their outperforming peer, averaging a 2% outperformance annually (for a total of 8% annually), will have a balance of $6,848,475.
Exhibit 1: 2% outperformance versus the average investor's return of 6%
In translation to real-world results, the outperforming investor will have access to an extra $250,000 of income annually in retirement.
Beyond the 2% comparison between a 6% and 8% return, if we compound the outperformance further, including investors who sustain outperformance of 10% and 12% throughout their lifetimes, the example becomes more clear - sustained outperformance at marginally higher levels has a significant impact on the total wealth of an investor. The below graph visualizes the extreme difference between an investor returning 6% and 12% annually.
Exhibit 2: Increasing marginal outperformance of an investor over 25 years
Over 25 years, the investor earning a 12% annualized return ends with a balance almost three times as great as the investor earning 6%. While a significant amount of the 12% return can be attributed to the risk premium associated with holding higher-risk investments, there is a middle-ground where risk mitigation and optimized wealth management strategies - like increased tax efficiency and cost savings on mortgages and credit lines - can be used to target the same 12% return with lower risk.
Thinking Beyond the Portfolio
In the above examples, we were talking about portfolio performance. However, as many investors know, sometimes the greatest returns come in the form of decreased costs over time. For an investor purchasing a home worth $1,000,000, the interest rate can be as high as 2.875%. Assuming a 20% down payment, the total amount of interest paid on this loan is $394,890 with a monthly payment of $3,319.
Compare this interest rate to a low rate financed through an advisor. For example, Chicago Partners, through a private partnership, can offer clients an interest rate as low as 1.25%. Were this same mortgage financed with help from Chicago Partners, the investor would save over $200,000 in interest over the lifetime of the mortgage.
Exhibit 3: Interest rate comparison over 10 years (2.875% vs. 1.250%) on an $800,000 mortgage loan
In the above example, the lower interest rate has saved the investor nearly $100,000 only ten years into the mortgage.
While obtaining an interest rate on a house is only one example of applied wealth management, the general theme can be expanded to all areas of an investor’s financial picture. For example, the capital saved in a low-rate mortgage can be reinvested, further compounding the value of the lower interest rate.
Whether it’s a low interest rate, intelligent use of margin through PAL lines or lines of credit, or an investment portfolio that achieves a slightly-better-than-average return through optimized asset allocation, the intelligent investor can accumulate these slight advantages to realize the 2% outperformance over their lifetime.
Chicago Partners' Strategies for 2%
At Chicago Partners, our advisors are consistently focused on finding strategies that give clients a sustainable outperformance advantage in their total wealth management plan. Focusing on the investment strategy alone is not enough - the truly optimized wealth management plan looks at tax consequences, financial planning, financing and banking solutions, insurance planning, and intelligent estate planning in order to build a comprehensive wealth management strategy that stays focused on an investor’s financial goals and objectives.
Our team of dedicated financial advisors - based out of Chicago, IL - are here to help you achieve your financial goals. Learn more about Chicago partners or peruse our wealth management blog for financial tips and advice! If you have questions about how Chicago Partners’ strategies may fit into your wealth management portfolio, please give us a call at (312) 736-0349 or contact us at the link below.
Important Disclosure Information
Chicago Partners does not guarantee any sort of return, including a 2% return. Based on market conditions, Chicago Partners may perform differently than a targeted 2% outperformance, either above or below the 2% mark. Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Chicago Partners Investment Group LLC (“CP”), or any non-investment related content, made reference to directly or indirectly in this commentary will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from CP. Please remember to contact CP, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. CP is neither a law firm nor a certified public accounting firm and no portion of the commentary content should be construed as legal or accounting advice. A copy of the CP’s current written disclosure Brochure discussing our advisory services and fees continues to remain available upon request.