Becoming a Millionaire -- A Real-Life Example

Adjusted for inflation, $5,000 in 1940 is equivalent to $66,500 today. $66,500 is no small amount of money now, and -- though I wasn't alive -- $5,000 was no small amount of money in 1940. The average salary at the time was $1,300, so he invested 3.8 times the average salary in that first year.

Investing $5,000 now might set you on the path to becoming a multi-millionaire in the year 2070, and you'll be better off than if you hadn't, but $1,000,000 won't go so far in 2070 based on historical inflation.

To get that same purchasing/giving power in 2070 that this guy has today, you'd have to start investing with $66,500 according to inflation or assuming the average salary today is $30,000, the same factor of 3.8 would require an initial investment of $114,000.

1940 average salary info: http://kclibrary.nhmccd.edu/decade40.html

The Power of Compound Interest

The Power of Compound Interest

Albert Einstein is quoted as saying, "The most powerful force in the universe is compound interest." When someone as brilliant as Big Al talks about the power of compounding, I don't know about you, but I tend to listen!

Well, here's another smart guy, this time from Kiplinger's, who says, "Time is the most powerful weapon in an investor's arsenal. Nothing comes close to it." Why? Because of the power of compounding. Here are some of his key thoughts:

• After 30 years of studying finance, I have found few eternal truths, but the most important -- the Golden Rule of Accumulation -- is this: Start early!
• Time is the most powerful weapon in an investor's arsenal. Nothing comes close to it.
• Let's do the numbers. The annualized return for U.S. large-company stocks (as represented by Standard & Poor's 500-stock index) for the past 80 years has been about 10%, not including taxes. Say your goal is to build a nest egg of $1 million by the time you are 55. If you start at age 24 and invest $5,000 a year at an annualized return of 10%, you'll reach your goal. But if you wait until you are 34 to start, you'll accumulate only $357,000 by age 55. If you start at age 44, you'll have just $107,000.
• How can this be? The answer lies in compounding, the fact that interest increases the value of interest as well as the value of principal. If you earn 5% on $1,000, after a year you'll have $1,050. After two years, you'll have not $1,100 but $1,102.50.
• As time passes, the power of compounding accelerates dramatically.
• One other important fact about compounding is that a small increase in the rate of return can produce a huge impact over time. In the case of the gift to your newborn daughter, if her portfolio returns 10% annually, then $10,000 grows to $4.5 million by the time she is 65. But if her portfolio returns 8%, then it grows to only $1.4 million. If it returns 5%, it grows to a mere $227,000. In other words, half the rate of return produces an account that's less than one-twentieth the size.

The article then ends with this conclusion:

But enough numbers. If you're a young person, all you need to know is that you must start early. If you are an older person who has young progeny or young friends, encourage them to start early. If you're particularly generous, set up a long-term trust or a Section 529 tax-advantaged college savings plan, or simply open a mutual fund account that the young person promises not to touch (or perhaps doesn't know anything about).

The piece then goes on to talk about where to invest your money. Me? I like index funds.

Just a great overall summary of one of the pillars of growing your net worth. Every person needs to know, understand, and apply this financial wisdom to make the most of their finances. I've been doing it for 15 years or so now and the power of compound interest is still really starting to take off -- it's really making a strong impact on my net worth. I can't wait to see what it does over the next 20 years!!!!

One of my favorite quotes about taking action is this:

The best time to plant a tree is twenty years ago. The second best time is now.

If you've lost a lot of investing time because you've procrastinated, just didn't know what to do, didn't have the willpower to save, weren't able to save, or whatever reason you might come up with -- stop fretting about it. It's water under the bridge. There's nothing you can do to get back that lost time. But you can still make a difference in your finances. How? Start saving today! 20 years from now, you'll be glad you did. ;-)