STEPS TO FINANCIAL SECURITY - Guide to Saving
History is full of very ordinary people who died millionaires. Sometimes luck played a role, but more often than not it was simple prudent saving and investing. The goal of this section of our web site is to share with you the basic principles of achieving financial security.
With that said, wealth could be defined as being able to buy whatever you want. But that is not a recipe for happiness. Happiness depends more upon delighting in what we have now.
The following are a series of perspectives designed to help you reach financial security. Ultimately whether or not you succeed in reaching your goals will depend on your decisions. Our goal is to provide you with the information you need to make the right decisions.
- Time and Compounding are the Investor’ Best Friends
Time and Compounding are the Investor’s Best Friends
When it comes to investing, the most important tool you have is time. A relatively small investment can become a sizable retirement fund given time and the impact of compounding.
Compounding is the process of earning interest on interest and dividends on dividends, over time. At first, your money grows relatively slowly, then with increasing speed as compounding takes effect.
One of the all-time great examples of the impact of compounding is the question…Which would be the better compensation plan?
- $100,000 per year with 10% annual increases
- One penny the first month, with your pay doubling with each successive month?
In three years, the individual who chose the $100,000 salary with 10% annual increases would have received $331,000 in compensation. The individual who chose the penny and saw her income double each month would have received $687 million dollars. Naturally, that’s compounding to an extreme. But the same basic principle holds true at lower rates of appreciation.
Suppose you invested $100,000 for 20 years at 8% annually with earnings paid quarterly. In one scenario, you withdraw your earnings each year. In a second, you reinvest those earnings at 8%. Assuming no taxes are paid, in 20 years, the account that is allowed to compound will be worth $488,640 - a $388,640 increase in value. If you had simply withdrawn your earnings each month, you would have $260,000, an increase of $160,000 over your original investment.
The sooner you put your savings and investment plan into action, the longer your money goes to work for you. And the longer compounding has to work its math, the more substantial your nest egg can become.
To enhance the power of compounding, you want to minimize the impact of taxes. After all, every dollar you pay in taxes reduces the amount you have to compound. For example, if you had to pay 15% capital gains taxes on your earnings each year, at 8% your account would grow to just $349,000 in 20 years. That’s why it’s important to invest as much as you can in tax-deferred retirement accounts, or better yet, a Roth IRA where earnings accumulate tax free.
Understanding the value of time and compounding is one step toward accumulating a healthy retirement fund, but the most important step is to do something. Until you set up a plan of steady contributions using an investment approach that works for you, you are letting time and the value it can bring slip away.
Nothing happens unless someone does something. Whether it’s for your own retirement or a young person’s, call me today and let’s put a plan in place to build financial security.
The compounding examples cited above are hypothetical and used for illustrative purposes only. Investment results fluctuate and past performance is not indicative of future results. The possibility of loss exists along with the potential for profit.