The idea for this blog post came to me after re-thinking what I have been for years on a daily and weekly basis. How to compound my savings from 20-35 earnings age into a small fortune by the time I reach the age of 60 years old. Most people have heard of the rule of 72 in relation to compound interest and finance. If you haven’t heard of it, I will explain it briefly here.
Now back to the original strategy of allowing your earlier years of work to reap hefty rewards or as the saying goes, “From a small seed may a mighty trunk grow.” – Aeschylus
< The Problem >
Save 2M of today’s dollars for retirement.
25-Year Average Inflation 2.89%
25-Year Average Annual Return of S&P 500: 11.01%
25-Year Average Real Return: 8.12%
FV = PV(1+ R) (to the power of n)
FV= Future Value
PV= Present Value
R= Rate of Return
n= Number of compound periods (I used years)
Using an average annual salary of 50K and a 40% savings rate from 20-35 you would be left with a sum of around $300,000 (We will assume you did not invest the 300K up until 35 and have achieved no return until now, VERY UNLIKELY, so the beginning sum may actually be quite larger)
FV= 300,000 (1+0.1101) (To the power of 25)
FV= 4,084,828.44 at the age of 60
Now this is not a very complicated approach to saving/investing and could be done through a passive investment in a low cost index ETF, accompanied by a buy & hold forever commitment.
The formula may be changed to assume lower or higher sums of money, compounding periods, or rate of return.
Due to annual inflation the Real Return would more accurately reflect your retirement purchasing power in todays dollar.
FV= 300,000 (1+0.0812) (to the power of 25)
FV= 2,112,380.65 at the age of 60
This calculation paints an increasingly bleak picture about the invisible tax policy implemented by central banks and policy makers, Inflation. But the bright side being the 2nd calculation excludes inflation leaving you with a real return or an equal amount of purchasing power in the future.
Now 2.1M (real dollars) or 4.08M (nominal dollars) may or may not be enough for your retirement depending on your desired lifestyle and leisure activities but this is besides the point. With a passive investment technique and no actual knowledge of the subject or ability to pick individual stocks has to be used. It is simply a low cost option that can be the foundation for a beginner investors portfolio. The commission fees, management expenses and taxes are all left at a minimum, allowing growth to truly take place for the individual investor.
“Compound interest is the 8th wonder of the world. He who understands it, earns it……he who doesn’t……pays it.” – Albert Einstein
(1930-2012 S&P 500, P/E ratio, Inflation, Data Available Below)