Hey there, folks. It’s been a long time. I’ve had a hectic schedule, combined with spending Christmas in Raleigh with my sister, brother in law and my two nieces along with some of my friends, so the holiday period has been chock full of activity. It’s alsoo my first time spending time with my nieces in years,so I’ve been in full uncle mode, buying Barbies, taking them to walks in the park and downtown, amusement parks, the mall, etc. I feel like a dad already, and I’m looking up the process for setting up investing accounts for two of them now that they’re 8 and 5 so that by the time they turn 18 I can hand them the results of compounding little amounts over a long time.
Doing the research for that finally gave me the idea to share with you guys, which is that by investing really small sums over a really long time, you can end up with millions in your account.
If you’re my typical ready, you’re in your early to mid twenties and you just graduated college. With a life time of smart decision making and investing, you can easily retire comfortably as long as you pay attention to several contributory factors.
- Earn a decent salary
If you make up to $40,000 a year in a mid range city almost anywhere in the country, you’re good to go. Anything less, and you will still be fine, but you might settle for a bit less. But anything up to $40,000 and up, you’re good. That means graduating from college with a good, competitive major in either STEM, Business, Accounting, Computer science, programming, teaching and so on. With that, earning $40,000 should be a piece of cake.
2. Max Out Your 401k and Use A Good Tax Shelter
For the typical person earning forty thou, you’re likely paying an effective tax of 28%, give or take. If you know your stuff, and you have a good position at a great firm, you should be receiving a company sponsored savings plan or 401k. If you’re at a job that doesn’t offer a 401k, that’s ratchet and you need to go to a firm that values your input. A typical 401k will let you save up to 20% of your paycheck, which is about $8,000.00. But since most company 401ks are structured as traditional, you make the deductions before tax, which removed about $2000 from your effective tax, which is the government’s way of encouraging savings. You can throw in that extra $2,000 to make it up to $10,000.00 in your 401k, or you can keep it and invest it in your own account. With company matching, (most companies do a 2x match) you get another either $12,000 or so which, added to your $8,000 amounts to almost $20,000.00 entering your 401k every year.
3. If you get the typical 2% raise every year, then your contribution increases accordingly. In addition, you select a 100% low cost index approach with your 401k which should earn you an average return of about 10%, and elect for all capital gains and dividends to be reinvested every quarter or year.
At the end of the typical 35 year career, if you’re lucky to live that long, what do you get?
In 10 years, you’ll have about $378.000.00
In 20 years, you’ll have $1.4 million
At the end of 35 years, when the government forces you to start making withdrawals from your 401k, you’ll have close to $7.5 million.
Even if we decided to go conservative and assumed an annualized return of only 6% which is lower than the typical 35 year return on the S&P 500 ever, you still end up with close to $4 million in your account.
It’s that simple. But that doesn’t mean it’s easy.
The reason most people don’t end up holding on long enough to see those kinds of returns are simple: fear and overactivity. Rather than pay attention to the underlying earnings power of the businesses they own, they fixate on the stock price as a measure of their gains. The problem is that during economic declines, or periods of bad news, the stock price can fall lower than is justifiable, and in the good times the stock price rises far beyond it’s value. That is because the stock market is an auction, reflecting how much demand there is for your equity stake in the moment, so you shouldn’t be surprised to see it fall over 50% at some points. In fact, if you hold your stocks long enough, it’s bound to happen. You’re supposed to do nothing when that happens.
But most people, due to their emotional state or lack of conviction, end up selling out when stocks decline, then buying when stocks are high which erodes any potential returns. Add the commissions and expenses of constantly trading in and out, taxes triggered, and bad timing, and you end up with the scenario where most people only get 3% returns annually, on a good day.
Investing is simple, but it requires discipline. It’s something I work on even now. For instance, I’ve set the goal for the next year to not sell any positions I buy into. It remains to be seen if I can do that.
For all of us, the goal should be to keep our savings up, max out our retirements, and then invest directly only when it makes sense.
Over time, that strategy has been proven to pay.