In these times of economic uncertainty many people are concerned about paying for their retirement. Pensions and Social Security are becoming less of a certainty. Most of the burden is being shifted to the individual in the form of Individual Retirement Accounts and 401k plans. As daunting as the prospect of saving for a retirement that could last over 30 years may be, you do have a powerful weapon on your side. It is the power of compounding stock returns.
If you want a method to get-rich slow, then you should consider compounding stock returns. The means in which you do this is by turning around and re-investing the dividends and profits that you make from your return. This may be a good alternative for someone who does not need the money quickly and who has the time to invest the money and wait for a return on their investment. This is not a way to get rich quick.
Beginning a savings program at a young age is even more important for people who want to take advantage of compounding stock returns. Let’s consider the case of two 19-year-olds, Bob and Ted. Bob has a good job and starts putting $2000 per year into savings starting at age 19. Ted, on the other hand, decides to sow some wild oats and put off saving until he’s 27. Assuming that Bob makes an annual return of 10% on his investment, by age 26 he will already have saved a whopping $25,159 before Ted even gets his act together
In the first example, if you were to stop making additional investments at the age of 27, someone who just started at that age would still have less money than you, even if they invested $2000 per year for the next 39 years. You will have $1,035,161 from a $16,000 investment while the other person would only have $883,185 from a $78,000 investment. This is simply an example to illustrate the power of compounding stock returns, and should not indicate that you should not make regular investments.
How can it be that a 26-year-old can earn more on the investments he’s already made than the amount he and his non-saving friend will add to their portfolios in the years ahead? This happens because our first young man saved such a large nest egg and earns interest on every year, so his friend will never be able to catch up with him even though he starts investing regularly at age 27.
It is important to reiterate that all investment income is reinvested. Neither principle nor income is ever spent. Saving money may be less fun than spending but the power of compounding stock returns is a simple way to secure your retirement.
With Pensions and Social Security becoming a less feasible way to support oneself upon retirement, many are looking at alternative retirement accounts as a way to make money through times of economic uncertainty. While individuals are left to sift thru many options for retirement accounts, like Individual Retirement Accounts (IRA) and 401k plans, many are now looking at the power of compounding stock returns. Put simply, the power of compounding returns could be described as a get-rich slow strategy. Rather than chasing performance and increasing risk in the form of the latest investment fad, you add regularly to your diversified investments and reinvest any income your investments produce.
- Mark Crisp
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