I was disheartened to review the latest study done by Dalbar Inc. (Dalbar.com), Quantitative Analysis of Investor Behavior, revealing that most mutual fund investors have squeaked out paltry returns within the last 20 years. For the 20 years ending December 31, 2009, investors’ annualized returns by fund type were: equity 3.17%, fixed income 1.02%, and asset allocation 2.34%. This is before we factor inflation into the equation and at that point the returns would make one violently-ill.

Why such abysmal returns? The report is a survey of investor behavior and the returns are a consequence of market timing. Regardless of where you are in the world you can find someone who is trying to take on more risk for a higher pay off. Practical theoretically, however it rarely rings true as the aforementioned statistical data attests.

It is also interesting to note that despite adherence to professional advice, investors are still fighting an upward battle. Those who practiced strict adherence to modern portfolio theory would not have avoided catastrophic losses following the downturn of 2008. The report adds:

Investment results in 2008 showed clearly that correlation of asset classes varied unpredictably and with no warning. This brings into question the very basis of MPT (Modern Portfolio Theory) and its ability to forecast an efficient frontier.

This statement makes investing seem a rather bleak proposition, however, I am not suggesting that we stop trying to grow our dollars, considering that S&P 500 Index funds did return an average annualized 5.4% during that 20 year period. Instead I’d like to advocate getting back to the basics.

What has encouraged me lately is the rising savings rate in the US. The rate was 3.3% in 2000 and as of July of this year we are resting around 5.9%. I’d like to see more Americans just practice saving more! The savings shortfall will incentivize investors to search for more alpha. The extra risk is not necessarily needed to get us to our goals if a little discipline is exercised.

Investors should conduct their finances as if they were running a business. Businesses can only afford to allocate so much money to infrastructure, marketing, and salaries and turn a profit at the end of the year. This should be your constant goal year in and year out. For every $1.00 that you make you should seek a consistent return on $0.10 of that dollar. Mark Twain was famously quoted as having said “I am more concerned about the return of my money than the return on my money”. Find a way to safeguard that 10% principle and grow that slowly. Starting at age 40, $10,000 saved per year, compounded at 6% interest turns into more than $580,150 by age 65.

It’s only after you have 10% of your assets growing in a conservative fashion (sans principle fluctuation) would I advocate riskier allocations. Savings should always precede investing. Most people are taught to start investing right away and they forgo establishing a strong financial foundation for themselves. It is important to note that the difference between saving and investing is that with investing you risk losing all your money. A lesson too many learned far too late.