Warren Buffett said “Risk comes from not knowing what you are doing.”
I say: Agreed. So let’s get to work.
The day you retire, you will have likely just hit the lottery, and everyone is eligible for this prize, almost guaranteed, to be a millionaire. Let me try to explain.
I have commented on the value of compounding interest several times in previous posts. I would like to share one more example of compounding interest in a slightly different manner, one that had shed a little more light on the subject for me.
I wish I could recall the podcast I had been listening to, but I can’t. The name of the speaker is not as important (other than giving credit for his work) as the message itself. He had been speaking about compound investing and how a majority of the money is made over the last few years. Superficially this should be obvious to anyone remotely interested in the subject, but he explained it in a way that made the concept tangible for me.
The speaker went on to explain: Imagine that you are in the largest stadium that you know of, in the very top nose bleed section, looking down at the field. You can see someone on the 50 yard line holding an eye dropper. This is not an average eye dropper, it has magic water in it. When he places a drop of water into the cup, it will double every minute.
How long do you think it will be before the water reaches your level? Apparently this talk is being given to a live audience and he entertains guesses: Four days, twenty four hours, two weeks, there are a variety of answers. The speaker tells everyone that they are all wrong, it will take fifty three minutes for the water level to rise and overflow the stadium.
As interesting as this is, it is the next question that really makes me think. How long does it take to fill two stadiums? Just sixty seconds more. How long to fill three stadiums? Only 30 more seconds, because in one minute the water will double in volume from two stadiums full to four. In the last thirty seconds, more stadiums were filled than the first fifty three minutes. You may be asking at this point, where is he going with this…..Don’t worry, there is a moral to my story.
I remember sleeping, I mean, sitting through a microbiology lecture in college in a similar topic discussing the exponential growth of bacteria in a Petry dish. Luckily I had a re-awareness of the discussion, just before the whiteboard eraser flew by my head, allowing me to duck. I understand exponential growth, logarithmic values and compounding, but the stadium discussion pulled it all together in a tangible way for me and helped me relate the value of compound and value investing, and comprehend their true benefits.
What do petry dishes, drops of water and flying erasers have anything to do with making money? In the past I have discussed compounding in relation to investing long term. The goal of that post was to put a face on the lifetime investment model and see how someone can reap the rewards with very little work. What I failed to do, was finish the thought, and add the mental exclamation point!
Let me revisit my thought process here. I discussed the benefit of making investments at a very early age and watching them grow to retirement. I’ll expand on the example I used of investing $200 a month from age 18 to retirement at 59 1/2. Saving this money in a reasonable investment manner averaging 8% interest each year (we all know historically it is likely to be more or less but lets be conservative) will net roughly $675,000 at eligible retirement age. Not bad for a minimal amount of monthly investment during that time frame. My hope is that you would be wisely investing more, but again let be conservative for argument sake.
Now, to add the exclamation point! What happens to that money if you decide to wait an extra year to retire? What if you choose to retire at 65? While we are considering retirement, lets also set up a scenario of full retirement at age 67, what will happen to that money. You do not have to postpone any retirement to enjoy the benefits of this scenario, I only suggest this to keep the math pure.
Age 59: Value of investment = $675,000
Age 60: Value of investment = $730,000
Age 61: Value of investment = $791,000
Age 63: Value of investment = $927,000
Age 65: Value of investment = $1,080,000
Age 67: Value of investment = $1,272,000
Age 70: Value of Investment = $1,611,000
The last seven years of growth, doubled what it took the first 42 years to achieve. There is no other way to do this at these levels, reasonably speaking, unless you are investing young, and compounding.
A few things to think about:
- This exercise is is based on minimal investments of $200 monthly. Imagine of you were actually putting away $300 a month, $400 a month, better yet, 15% a month to grow proportionally as your salary grows putting even less burden on your financial position.
- $300 a month looks like this:
- Age 59: $1,000,000
- Age 63: $1,391,000
- Age 65: $1,630,000
- Age 67: $1,909,000
- Age 70: $2,416,000
- Almost an additional $1,000,000 simply for an extra $100 a month @ age 70.
- $400 a month looks like this:
- Age 59: $1,347,000
- Age 65: $2,173,000
- Age 70: $3,222,000
These calculations assume that you are not removing any funds through distribution and that you are reinvesting any dividends. Of course when you decide to retire and start living off your investments, the forward projections will decrease slightly.
Now, I am about to really blow your mind. Imagine that you put this money into a Roth IRA. Remember the benefit of a Roth? Think about it, think……keep thinking…….you got it! This money will all be tax free when you decide to withdraw. It is all yours to spend how you see fit, with no more interference from government theft under the guise of taxation.
As I mentioned in the beginning of this post, we all have a chance to retire a millionaire. It is relatively painless over an extended period of time (granted, it will be difficult at in the early years), but it just takes discipline, the willingness to learn, and motivation. It’s never too late to start on your first million dollars, remember this process is a marathon, not a sprint.