Compounding is all about time. The more time you have the more effective it is. The younger you start the higher the rewards. What does it take to convince the 25 year old to start investing?
The premise of this blog is that I created a plan to become a millionaire and I set a goal to do it in 10 years. I succeeded (with a slight delay due to the great recession). My portfolio now exceeds a million dollars. What is amazing is that out of that million I never invested more than 450 thousand. Most of my portfolio consists of unrealized gains.
The last 3 years, prior to me leaving my job for a long deserved break, my annual unrealized gains exceeded my annual after tax income. My money was making me more money than my job was!! How did I do this you may ask? Well it wasn’t all me, it mostly had to do with compounding. For compounding to really kick in it takes time. For me it took 10 years and it only gets better going forward.
Compounding is about generating earning from previous earnings. So, back to why it is I wish could reach the 25 year olds; the earlier you start the more earning are there to generate more earning on.
Compounding is so much more effective when you start young. If you start at 25 and continually contribute $300 a month to an investment account with 8% annual return (some might call that conservative) you’ll have more than a million by the time you turn 65, yet you only invested $144,000
If you start at 50 to reach a similar amount you would need to invest $3,000 a month. You’d end up with a similar amount but having invested $540,000.
Let’s put this in different terms:
Option 1: Put away $108,000 and get 1 million in return.
Option 2: Put away $540,000 and get 1 million in return.
Hmmm, let’s try another one:
Option 1: Put away $200 a month and get 1 million in return.
Option 2: Put away $3000 a month and get 1 million in return.
Put in those terms it all seems like a no brainer, lets go with option 1. The huge difference between total investment of $108,000 vs $540,000 or monthly investment of $200 vs $3000 is all determined by one factor: TIME. Let me repeat: TIME. The younger you start, i.e. the more time you give yourself; the greater the returns!!
If only I could convince that 25 year old to start putting away that $300. I realize that to a 25 year old $300 a month is a lot of money. The 25 year old may be busy putting that money towards his or her student loans but, if at all possible I would like to see him or her divert some of their money towards their future along with paying of their past (don’t stop paying of that student loan).
I myself learned things the hard way, and even though I did just fine, I would have done so much better had I known at 25, what I know today.
I came to the United States in 1997 and didn’t really start investing consistently until 2000. This was after I mentally (and financially) recovered from the internet bubble bursting. I invested before, but lost most of it in risky deals. Let’s just say Enron Employees weren’t the only ones investing their 401(k) in their company ticker only.
Had I started investing earlier and less risky (let’s say I invested in SPY only) I would have made considerable more. Granted I didn’t make as much money back then as I did in the last couple of years but that doesn’t matter. It wouldn’t take much, compounding would have taken care of it.
Had I invested $300 a month each year from the age of 25 in SPY only (that would have been 1995 for me) to 2000 I would have had considerable more than I have today. An investment of $21,600 over 6 years would have gotten me about $80,000 more than I already had on January 2015. This is based on the actual returns of the SPY along with the reinvestment of its dividends. That is on top of the million plus I already made doing it the hard way by actually investing $3,500 a month for 12 years.
That same initial investment of $21,600 would have potentially gotten me an additional $372,000 by the time I turn 65 assuming an annual return of 8% on the SPY going forward.
If I take those additional $300 a month along with the investments I actually made from 2001 till 2014 and stopped investing today (probably won’t) I will be looking at the following picture for my future:
The growth past that first orange bar would be ALL Compounding. If I get a job today that will pay for my daily expenses and don’t invest a penny more, my investment will go from 1 million to close to 5 million by the time I turn 65. All through compounding!
So if you’re in your twenties and you actually stumbled upon this article. I don’t know what more I can tell you to convince you. Open a broker account, keep control of your own money. If you’re okay with tying up your returns till 59,5 then open a ROTH IRA, limits won’t be an issue at 25 yet. Put aside some money every month, invest it and LEAVE IT ALONE. I’m not saying it will be easy today to set aside $300 but give it a try. Don’t buy that car you cannot afford. Forgo those aluminum rims. Settle for less stereo and gadgets in your new car. Try to skip getting that new iPhone for one more year. Don’t buy Starbucks coffee for a couple more years. DO NOT fall for that idea a wedding has to cost $30,000. The little money you’ll be able to invest will reap you great benefits.
If you’re no longer in your twenties and decided to read this article (cause I told you so in the title), don’t give up. There is still time. $300 a month won’t work for you anymore but you can increase your contributions. Instead of sinking that next pay raise into your new car, set aside some of it to invest. If you need tips of cutting your cost in order to increase your contributions read my book or read my series on budgeting that may allow you to free up money. We managed to cut our expenses by $20,000 a year and I never considered myself living above our means.
So here is my advice to you: Start today and let time be on your side.
Good luck reaching your financial goals.