I like to talk about money and finance, a subject I know pretty well after 33 years as a financial advisor. Many people don’t like to talk about their personal finances. While sex may be the most personal and private topic to discuss, I think the money discussion runs a close second. Certainly there are many people who would much rather talk about their sex life than their financial life.
Some of the uncomfortableness surrounding money comes from a lack of understanding the subject. The blame goes to many factors including the misinformation we get from others including our parents, a lack of financial literacy taught in our schools and the financial industry itself. Yes, the industry likes to make things more complicated and confusing than need be. I’d like to add some clarity here by simplifying the basic factors of any investment.
There are three basic factors of any investment. It doesn’t matter if the investment is a stock, bond, mutual fund, exchange traded fund, house or other real estate, or a bank account. The three factors are time, rate of return, and money. ALL are important to accomplish your financial goals. None can be omitted but all can change. For example, if you reduce the investment timeframe, you would need more money to invest or you’d need to achieve a higher rate of return.
Table 1 shows a financial goal of having one million dollars by the age of 65. Keeping our rate of return constant at 8%, the shorter our timeframe, the more money we must commit. While a 25 year old may not have $46,031, or find it difficult to save $286 per month for 40 years; a 55 year old who doesn’t have $463,193 may find it impossible to save $5,466 per month during the last 10 years of their working career. The table demonstrates the dramatic impact time has on the achievement of investment goals.
The rate of return on our money can be just as dramatic. Obviously the 8% assumption won’t be achieved in a bank savings account but could it be achieved in the stock market? I had the pleasure of having lunch with Roger Ibbotson several years ago. While at Yale University, Professor Ibbotson researched returns on several broad categories of investments going back to 1926. While he sold Ibbotson Associates to Morningstar in December 2005, Morningstar has continued to update his research. As of December 2016, the compounded returns on stocks were 10.1% annually. If I had assumed 10% instead of 8%, that 25 year old would have $1,824,000 at the age of 65.
What if the 25 year old saved $286 a month in the bank at 2% return? At 65, they would have only accumulated $210,000. Put another way, our 25 year old would have $1million by putting away $286 per month in 98 years or at age 123!
I’m not recommending investing in either an all stock portfolio or 100% in a fixed bank savings account. A well-balanced portfolio usually makes sense for most people. But what could be more important than trying to maximize your rate of return every year? What is the number one determinant of funding a successful retirement or a college education??? The answer is funding, of course!
Our 25 year old wants to retire early. They will still need the $1million, but want to stop working three years early, at age 62. They would save $400 per month. If they wanted to retire 8 years early with $1million, they would need to save $572/month. Before you think this is an impossible task, just ponder this real life scenario. Our 25 year old puts away 3% of a $57,200 salary. Not far-fetched for a nurse, a teacher with a masters, or others. Suppose their employer matches 100% of the first 6% contributed to their retirement plan. The total contribution is $286/month. Now at 26 they get a 3% raise and for this year only, they take the entire raise to put into their retirement plan and never increase their contribution again. They are now contributing $572 per month and are on track to retire at age at age 57.
One of the surest ways for investors to fund a financial goal is to contribute an adequate amount to the investment. This is the one factor over which investors have the most control. This would require some discipline and financial maturity. Financial gurus and common sense sages, Robert and Jacquelyn Beale (who happen to be the parents of the author) once defined maturity to me as “being able to delay present gratification for a greater long term benefit”. My mom has taken her own advice to heart. While she enjoys a wonderful and active life, she continues to save part of her income monthly for her future! Thanks mom, for giving me practical advice and understanding of the basic factors of investments.
