By: Gene Walden, Senior Finance Editor September 14, 2017
"A study of economics usually reveals that the best time to buy anything is last year."
- Marty Allen
Making long-term investing a priority today can be particularly difficult when there are so many other financial needs that command our attention.
But there is a very good reason to start investing as soon as you can – the power of time.
By starting now, you may be able to achieve the same long-term results with just a fraction of the capital that you would need if you were to start several years from now.
Value of a Head Start
Here’s an example of how the power of time could play out in your financial life:
Let’s say you have a good job with a good salary and every month for 10 years, you invest $100 in a mutual fund in your 401(k) retirement plan at work. For the sake of this example, let’s say you will earn an annual rate of return of 7% after fees and expenses.
Keep in mind, this is strictly a hypothetical example which will assume the long-term average rate of return is earned annually and is not intended to represent any specific security. Your actual returns would likely differ based on factors such as future performance of the markets, what you’re invested in, how long you leave the funds invested and when you choose to withdraw the funds. Individual investment decisions should be made based on your needs, objectives and time horizon.
Based on the example above, over the first 10 years, including all contributions and gains, the total amount in your 401(k) would have climbed to about $17,409– $12,000 in contributions and $5,409 in gains. After 10 years, you decide to stop adding money to your retirement account in order to start saving for your children’s higher education. But you leave the money in your 401(k), and it continues to grow at the same average annual rate of 7%.
You mention your retirement investing to your neighbor at the summer picnic. As a result, your neighbor starts investing the same $100 a month in a 401(k) in the same investment earning the same hypothetical average annual return of 7%.
After 10 more years, your neighbor would have about $17,409 in the portfolio, and you would have about $34,987 – even though both of you had contributed exactly the same amount – $12,000. Even though you have stopped making monthly contributions, your account continues to grow as you are now earning on your earnings as well as your initial investment thanks to compounding.
To catch up, your neighbor decides to continue making $100 monthly contributions, earning the same 7% return. After 10 more years, your neighbor would be up to about $52,396, and you would be up to $70,312 – even though you had invested only $12,000 compared to your neighbor’s $24,000.
Still determined to catch up, your neighbor continues adding $100 a month to the same portfolio at the same rate of return. After 10 more years, your neighbor would be up to about $122,707, but you would still be the leader at about $141,304 – even though your neighbor has now invested $36,000, three times as much as you originally invested.
With only 10 years left before retirement, your neighbor decides to do everything possible to overtake your advantage – doubling the monthly contribution to $200 per month. After 10 more years, your neighbor has nearly closed the gap, with about $282,418 in the portfolio. But your account has grown to $283,973 – an advantage of about $2,500 – even though your neighbor has now invested $60,000 over 40 years while you invested a fifth of that amount – $12,000 over 10 years.
The key, of course, is the power of time. You only had to invest a fraction of the money for a similar outcome simply by starting 10 years earlier.
The tables below show the growth of each of the two portfolios – the early starter and the late starter – over the 50-year period based on the average annual return of 7%.
The Value of Time
Comparative long-term returns based on 7% average annual return with monthly compounding.
This is a simplified, hypothetical example and does not consider any unique circumstances such as fees, withdrawals, or varying positive and negative performance potential among years.
Generally speaking, actual performance will vary from year to year, with some years above average, some about average and some below average, but, in this example, the investment produces an average annual return rate of 7% over time. It is also important to remember that investing involves risks, including the possible loss of principal. All of your investment decisions should be made based on your specific financial needs, objectives, goals, time horizon, and risk tolerance which may change over time.
What are the lessons here?
It’s never too late to start investing, but starting sooner rather than later may make reaching your financial goals considerably easier – and cheaper.
To quote an old Chinese proverb, “The best time to plant a tree was 20 years ago. The second best time is now.”
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