Thanks for checking out “A Dollar and a Dream!” I appreciate you for joining me on the journey of creating financial freedom for our children. For me, life is all about setting up the next generation for better success than you had. Think about it. My grandparents (Born in the 1920’s and 1930’s) come from very humble beginnings. Both of my grandmothers cleaned houses for wealthy people, one of my grandfathers worked in furniture repair, and the other grandfather sold insurance (he did pretty well for those days, lol). They did the best they could with the resources they had. They had to deal with so many issues going on at the time, namely racial discrimination and segregation. My parents (born from those humble beginnings) took the ball and advanced it a little further. My Mom became the first in her family to graduate from college, and my Dad learned a trade as an electrician out of high school and started a career in that field. My parents’ generation were the first to get corporate jobs. They also faced the same discrimination that their parents faced earlier in life, so I’m sure they were just happy to get a foot in the door with real companies. Today, my generation is in the early to mid part of our careers, and we don’t have those barriers to deal with. Yes, we still have biases in the workplace. Yes, there are still issues with climbing the corporate ladder when you look like us. However, these issues pale in comparison to what my parents and grandparents dealt with. My generation is pushing the ball a little further, and we’re demanding opportunities in management and leadership in the workplace. Part of us advancing the ball further (IMO) is saving our money early for our children and really educating ourselves about stocks and how they work, so that we can effectively grow their money.
So, why should you invest early and often for yourself or for your children? Two words answer that question entirely….”COMPOUND INTEREST”. Albert Einstein once described compound interest as the eighth wonder of the world. He is quoted as saying, “He who understands it, earns it; he who doesn’t, pays it.” Compound interest is defined as the addition of interest to the principal sum of a loan or deposit. In simple terms, it is defined as earning interest on top of previously earned interest.
Let’s take a look the concepts of simple interest vs. compound interest. If you invested a lump sum of $10,000 and earned simple interest of 8% per year, your earnings portfolio would be worth $10,800 after year 1, $11,600 after year 2, $12,400 after year 3, and so on and so forth. If you invested a lump sum of $10,000 and earned compound interest of 8% per year, your earnings portfolio would be worth $10,800 after year 1, $11,664 after year 2, $12,597 after year 3, and so on and so forth. With simple interest, you earn interest based off the original amount invested. With compound interest, you earn interest off of your new portfolio total at the end of each year. Investing in stocks allow you to compound your money over time. If you pick the correct investments, you’re able to compound your money faster than others. Check out the illustration below of simple interest vs. compound interest. Your money starts growing slowly at first, but then it eventually diverges and starts growing exponentially (red line) as the years go on.
Allowing interest to compound over many years is the reason why I started investing for my kid so early. The earlier you start, the more time compound interest has to work its magic. Please see the chart below that shows the differences between starting early, and waiting to start later in life. The age you would start investing is in the left most column, and your range of portfolio returns are the right 3 columns.
| Portfolio Totals @ age 25 (contributing $200/month) | |||
|---|---|---|---|
| Starting Age | Annual Percent Return | ||
| 6% | 8% | 10% | |
| 0 | $138,599 | $190,205 | $265,367 |
| 5 | $92,408 | $117,804 | $151,874 |
| 15 | $32,775 | $36,589 | $40,969 |
| 20 | $13,954 | $14,695 | $15,847 |
As you can see, the earlier you start, the larger your portfolio. If you waited to start later in life, you’d have to contribute significantly more out of your pocket, just to make up the difference. Even then, it will be hard to catch up. This principle is applicable for young professionals as well. INVEST EARLY AND OFTEN in your 401k’s. If you wait until 40 to try and make up ground for lack of putting money away in your 20’s and 30’s, you will find it impossible to catch up. Let compound interest go to work for you in your early years. As you get raises each year, just increase what you’re putting towards your retirement. You won’t regret it.
Returns over the last 100 years (with dividends reinvested) have been around 10%. Jack Bogle (founder of Vanguard, creator of low cost index funds) predicts that returns will be much lower (~6%) going forward. Who am I to question that? I predict I can earn Nicholas (~7%) per year. With plans to increase how much we’re contributing per month as he gets older, he will be around the $250,000 mark by the time he’s 25. The message here is to please save early and often for your kids. Just save something for them (doesn’t have to be a big amount). The earlier you start, the better off they’ll be! As always, feel free to check out Nick Jr’s portfolio (updated monthly). I’m an open book! If you have questions, drop me a note and I’ll be more than willing to answer them.