Ok, this will be a bit basic for many of you reading this, but every once in awhile (ok, quite frequently) I like to review the basics of personal finance. You know, the simple, little things that anyone can do to make a HUGE difference in their net worth.
Today, I want to highlight a piece in USA Today that says one of the keys to investing is to start early. It details what a big advantage this is by giving an example of the power of time and compounding in investing:
Let's say you [17-year-old] and a 47-year old start investing at the same time. And let's say you both want to have $1 million by the time you turn 65 and you both get 10% annual returns.
To reach that goal, the 47-year old will need to save and invest nearly $22,000 a year, or $396,000 over 18 years. You, on the other hand, can have a cool $1 million waiting for you by investing just $1,000 a year, or $50,000 over 48 years.
Man, I love time and compounding when it comes to investing!!!! ;-)
As I've noted in other posts, I've been investing for 15 years or so and I'm just starting to see some pretty big gains from compounding. It takes awhile for the effects to kick in, but when they do, they are massive.
Just think of a snowflake rolling down a hill. Eventually it turns into a snowball, then a snow mass, and then an avalanche. That's just the way compounding works when it comes to investing. I'm now between the snowball and the snow mass phases and am eagerly anticipating the avalanche phase. ;-)
For more of my thoughts on this issue, see An Example of the Power of Compound Interest.
I started very early but then I blew all my money on college and ended up with student loan debt and a minimum wage job.
Posted by: Minimum Wage | June 04, 2007 at 09:27 AM
FMF, good post. There have been a ton of posts on this subject around the PF blog community, but this point is so important that it probably needs to be pounded and pounded into our brains. I have friends in their late 20s who have been working for years and have not saved/invested much, if anything. What a missed opportunity.
MW-- I've seen your comments all over the PF blogs. Do you have a blog yourself? Every time I see your comments I wonder about your story . . . why a college grad continues to work for minimum wage, etc . . . and why you post all these comments. On the surface you seem really negative, not only about college and about your job, but about the advice given on these blogs. Seems unhealthy.
Posted by: Brad | June 04, 2007 at 09:58 AM
One problem with this. Assuming a 25% tax bracket and 3% inflation the 17 year old's money would only be worth $125,000 while the 47 year old's would be worth $550,000. Compounding is great but inflation sucks. The 17 year old would need to save over $4000 to end up with a similat amount. It still means he needs to save less.
Posted by: JJobyone | June 04, 2007 at 10:03 AM
I've only started investing 4 months ago. I can't wait until I see huge returns. For me... when I see a short term one day gain of $100, I get excited. I can't wait until $1000 or $10,000 in one day.
Posted by: A Tentative Personal Finance Blog | June 04, 2007 at 12:09 PM
You talk about the power of compounding with regard to the amount of money one will have when one is ready to retire if one starts saving early in life. However, you must also point out the the power of compounding with regard to inflation also effects the value of the dollars saved not only before retiring; but, more importantly AFTER retiring. If one retires at 65 and lives another 25 years, assuming a 3% inflation rate, then the one million saved at retirement would be worth only $477,555. In other words, if you plan to have one million dollars at retirement and expect a 7% return on that investment to fund your retirement, the $70,000 you plan to live on will be worth only $33,428 in constant dollars by the time you are 90 years old.
In other words, when saving for retirement, you must not only consider the power of compounding when calculating the amount of money you will save, but, you must also consider the power of compounding with respect to inflation (both before and after retirement) when calculating the amount of money you will need to retire comfortably for the rest of our life.
Therefore, rather than assuming that the one million dollars you have saved will provide a $70,000 retirement income; you should assume that even though your investments may earn a return of 7% annually, you can only live on $40,000 and must let the other $30,000 (or 3% of your assets) stay and continue to earn the 7% return in order to stay even with inflation. Or, to put it another way, if you expect a 7% return on your assets and you expect you will need $70,000 per year to maintain your desired life style, then you need to have saved one million seven hundred and fifty thousand dollars.
Posted by: Scott K | June 04, 2007 at 02:37 PM
Brad - I have a liberal arts degree and nothing which could be considered "career-related" experience. As a boomer, my peak employability years have passed, and I have negligible expectation of ever getting a non-menial job.
I currently work for my state minimum wage in an inner-city convenience store which seems to be a magnet for a wide array of walking social problems. Our sales volume is heavily based on alcohol, tobacco, and porn. I despise many of the lowlifes who come into the store (I love the normal people) and slither home at night cursing my miserable existence.
Posted by: Minimum Wage | June 04, 2007 at 04:04 PM