Hey everyone, I’m back with another tip of the week! When discussing investments as part of a financial plan, we often get bogged down in the details… things like individual fund selection, expected annual percentage returns, risk tolerance, past performance, etc., etc. Sometimes, those details, while important, cause us to miss the forest for the trees. In the practical application of financial planning and investing, the more important question is how many times can we double our money?
This concept combines the two important factors of asset allocation and time and demonstrates the effect of compounding. So here is an example scenario that I discussed with a potential client this week. Let’s say you are 35 years old and the plan is for you to be ready to retire at 65. That’s a plain vanilla goal, but also common. You choose an asset or investment allocation that we expect to earn about 7% returns over that time frame. From year to year, of course, that return can vary widely. At that rate of return, you could expect to double your money every 10 years, meaning your money will double three times by age 65. If you start with $100,000 today, your first double takes you to $200,000. Your second double takes you to $400,000. And your third and final double takes you to $800,000.
Now let’s take that same scenario and assume that you pick investments that are expected to return 10% per year. Now, even though that is the historical average equity return, it’s a little on the high end as a planning factor. That said, the 10% return would double your money about every 7 years, meaning over that 30 year period, you would double your money four times instead of 3. Let’s walk through the numbers again. $100,000 becomes $200,000, then $400,000, then $800,000. And that fourth double takes you all the way to $1.6 million. A massive difference, right?
That’s the power of compounding over time… and the stark difference in a few percentage points of return that doesn’t seem like a big deal in the short run… AND why it’s so important to start a deliberate investment plan as soon as possible. It’s unlikely for most people that they will be able to save $1.6 million in those few years before retirement… but that number is achievable for someone who starts early because compounding is so powerful. But you have to start! You can’t get that huge last double without the first double.
And look, I get that not everyone is sitting on $100,000 at age 35 or that returns are going to work out in a perfectly predictable manner. Though we can’t control investment performance, we can control our actions, establishing a proper financial foundation, living below our means, and investing the difference toward a desired outcome.
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Remember, the topics discussed in this video are for informational purposes only and that past results do not guarantee future performance. If you would like to discuss your financial situation, please email me at Derek.Merkler@Parsonex.com.
Advisory services offered through Parsonex Advisory Services, Inc., 8310 S.Valley Hwy, Suite 110, Englewood, CO 80112. 303-662-8700.