THE POWER OF COMPOUNDING

Remember all the time we spent as children dreaming about what it would be like to be a millionaire? Surprisingly, if we had spent that same amount of time running a candy store or a lemonade stand, we would all be on track. Why didn’t anyone tell us it was so easy! Of course, many adults don’t comprehend the power of compound interest, so I suppose we should give ourselves a bit of a break, but here is the secret: assuming historical investment rates of return hold steady, a 10-year old would need to invest only $25.52 a month during his lifetime to be a millionaire by age 65.

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Regardless of your investment goals, the key to collecting wealth is to invest early and often. The S&P 500 has averaged an annual return of 10.36% since 1926. That average includes such tumultuous times as the Great Depression, the inflation crisis of 1973-1974, and the bursting of the tech bubble in 2001-2002. Assuming this rate of return, a 25-year old would only need to invest $141.66 a month to have a million dollar portfolio upon retiring at age 65. Compare these figures to a 55-year old who must invest $4,781.89 a month to have a million dollar nest egg at retirement and the benefit of investing early and consistently are clear.

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These numbers are yet to incorporate one very important factor: inflation. After accounting for an inflation rate of 3%, which is representative of historical norms, the 25-year old investing $141.66 each month will have a nest egg of $387,866 upon reaching age 65. Assuming the individual will live until age 90, these savings will provide approximately $33,734 of inflation-adjusted income annually. This is a substantial amount, especially if these savings will be supplemented by an employer sponsored 401(k) or social security. (If you’re curious, a 25-year old would need to invest $365.23 a month to have an inflation-adjusted net egg of $1,000,000 upon reaching age 65, and that would grant the retiree an annual income of $86,973 until age 90). Further, assume the individual is married and their spouse followed a similar investment strategy since the age of 25. That couple would have an inflation-adjusted income of $67,468 annually until reaching age 90. This amount should be sufficient to support the couple even without additional benefits from social security or employer contributions to retirement accounts.

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Armed with this knowledge, individuals should closely monitor their spending and savings habits. Ideally, investors should save between 10% – 15% of their gross earnings. If you are still having a hard time saving, consider this: a general rule of finance is that your investments should double in value every seven years. Thus, a 25-year old has the option of spending $200 on the new Rock Band video game, or investing that $200 and watching it grow to $400 at age 32, $800 at age 39, $1,600 at age 46, $3,200 at age 53, $6,400 at age 60, or $12,800 at age 67. I’m sure the game could provide hours of entertainment, but is it really worth $12,800 at retirement?

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Developing a strategy to meet income goals is what financial planning is all about. Speak to a financial advisor to determine the amount you should be investing monthly to provide you with the retirement you envision.

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