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Miracle of Power of Compounding in Wealth Creation
THE POWER OF COMPOUNDING IS THE MOST POWERFUL FORCE IN THE WORLD
THE POWER OF COMPOUNDING IS THE MOST IMPORTANT OF ALL WONDERS OF THE WORLD
THE BEST TIME TO INVEST IS FROM AGE ZERO, AND THE SECOND BEST TIME IS NOW.
"...work like you don't need the money..."
"Let money work for you."
By
DILIP RAY
The Power of Compounding (POC): Affects many aspects of life:
1. Wealth creation
2. Disease: spread & prevention
3. Population dynamics, politics, and the future of the world
This book will be on wealth creation.
Copyright:
2009 by Dilip Ray. All rights reserved
No part of this publication may be reproduced, stored or transmitted by any means and form, photocopying or scanning except author’s permission.
Disclaimer:
The author has used the best efforts in preparation of this book and makes no guarantee with respect to the accuracy of the contents of this book,
There is no advice. Facts presented and strategies are made and may not be entirely correct and suitable for the readers. The reader should seek appropriate professional advice before making any form of investment.
Past performances are no guarantee of future performances.
The author will not be liable to for any loss of profit or any kind off damages.
Acknowledgement:
I greatly appreciate the efforts made by Ms. Ashley Carlyle in preparation of this book including editing.
POWER OF COMPOUNDING (POC)
&
WEALTH CREATION
INDEX
Page
Introduction 5
History 6
Definition 6
Mechanism POC & examples 7
Difference between simple and compound interest 9
Calculation by rule of 72 11
Starting time of investment & POC
starting early vs. late? 13
Rate of Interest & POC 32
POC also Works reverse Way: Paying off Home
Mortgage Early 38
Procrastination 45
College & University Endowments 48
Creating wealth for children 54
Paying the Annual Tuition to Attend Private School
vs.
Saving Money by Attending Public School for Free
& Investing the Money Saved 55
Earning an Undergraduate or Postgraduate Degree 60
vs.
Getting a Job and Making Investments
Real life & hypothetical examples 89
Effect of dividends on growth of Investment 143
Can POC fail? 145
Summary
Conclusion 151
Miracle of Power of Compounding in Wealth Creation
Introduction
POWER OF COMPOUNDING (POC) is a mathematical concept that has been around since ancient times. Based on the concept’s potential for wealth creation, POC has been called the "most powerful force in the world," the "8th wonder of the world," a "miracle," and the "money bible." The first two claims have been attributed to Albert Einstein* although formal proof is lacking.
Throughout history, POC has been largely overlooked as an investment tool. The reason may be that the concept is not well-known or widely understood by the world’s population. Most likely, the oversight is due to the fact that POC, in most circumstances, is dependent on many years of patient waiting to reap the rewards. As such, POC may be the perfect example of the classic quote from Aesop’s fable of The Hare and the Tortoise: "Slow and steady wins the race."
POC is rarely included in school curriculums or elsewhere, thus making the concept an unrealized, unappreciated, and underutilized mechanism of investment. History has shown that even well-educated people and politicians who are aware of POC’s earning potential have been known not to take advantage of the concept’s ability to generate untold wealth.
POC affects aspects of life other than wealth creation. The spread and prevention of disease and the interrelationship between population dynamics and politics are also influenced by the concept. The financial aspect of POC will be analyzed and the practical application of the concept will be evaluated to prove why POC is the 8th wonder of the world, a miracle, and the most powerful force in the world. Use of repetition in the text is intentional to reinforce the importance of POC in the creation of wealth. The other two aspects of POC will be addressed in future books.
*Millard Fillmore’s Bathtub. Einstein, compound interest: Does not compute.
Comment by fact checker 07.11.06.
http://timpanogos.wordpress.com/2006/07/22/einstein-compound-interest-does-not-compute/
History
Most likely, the idea of compound interest evolved from the practice of lending and borrowing back in the early 1600s. The lender would get back something more (interest or dividend) from the borrower than just the original amount of the loan (the principal). The following two quotes are from the history section for the topic of "compound interest" in Wikipedia, the free encyclopedia:
"Richard Witt's book Arithmetical Questions, published in 1613, was a landmark in the history of compound interest. It was wholly devoted to the subject (previously called anatocism), whereas previous writers had usually treated compound interest briefly in just one chapter in a mathematical textbook. Witt's book gave tables based on 10% (the then maximum rate of interest allowable on loans) and on other rates for different purposes, such as the valuation of property leases. Witt was a London mathematical practitioner and his book is notable for its clarity of expression, depth of insight and accuracy of calculation, with 124 worked examples."
"Compound interest was once regarded as the worst kind of usury [interest], and was severely condemned by Roman law, as well as the common law of many other countries."
Source: Wikipedia, the free encyclopedia. Compound interest (History)
http://en.wikipedia.org/wiki/Compound_interest
Definitions
An investment is made to get a return on the investment. The return may be interest, a dividend, or something else, such as bartering. There are two kinds of interest: simple and compound.
Simple interest is interest that is calculated on the initial investment (principal) only and not on any interest previously earned. For example, a $1,000.00 investment that earns 10% simple interest (i.e., $100.00) each year for 8 years will continue to earn $100.00 each year. There is no compounding. See Table 2 below.
Compound interest is interest that is calculated on the original principal and on all previously earned interest. Because the interest earned each period becomes part of the interest-bearing balance, the principal base keeps increasing. Think of compound interest as being "interest earned on interest." The compounding frequency may be continuous, daily, weekly, bi-weekly, semi-monthly, monthly, quarterly, semi-annually, or annually.
Compound interest is also referred to as Annual Equivalent Rate, Effective Annual Rate, Annual Percentage Rate, and Effective Interest Rate, among other terms.
Source: Compound Interest, From Wikipedia, the free encyclopedia http://en.wikipedia.org/wiki/Compound_interest
In contrast to simple interest, a $1,000.00 investment that earns 10% interest, compounded annually, for 8 years will earn $100.00 in interest after the first year, $110.00 in interest after the second year, $121.00 in interest after the third year and so on through the life of the investment. See Tables 1 and 2 below. If enough time is given for POC to work, the growth of the investment can be exponential.
Exponential growth occurs when an investment regularly increases by the same percentage. The investment will continue to grow year after year as the compound interest accumulates. Eventually, the compound interest will exceed every year and then every month, every week, every day, every hour, and so on. Basically, the larger that the quantity gets the faster that the quantity grows. If given enough time, the original balance will grow beyond all expectations. No wonder POC is called the 8th Wonder of the World!
To accumulate wealth at a faster rate, a person would need to add additional principal as often as possible, without withdrawing any money from the investment pool. A higher interest rate would also accelerate the process.(See page --)
POC is the reason why the endowments at Harvard, Yale, Johns Hopkins, and many other universities and organizations are in the billions of dollars and will be in the trillions of dollars in the next several centuries. For example, if Harvard continues to invest in the same manner in the future as in the past, its endowment is on track to surpass the trillion dollar mark within the next 90 years. (See Page--)
The Mechanism of POC
The mechanism of POC is a simple, doable, and very powerful method of investment. There are many compound interest calculators on the Internet where all a person needs to do is fill in the appropriate information [principal, interest rate (e.g., 5%, 8%, 10%), number of times per year interest is compounded (e.g., daily, monthly, annually), and number of years invested] to find out the future value of an investment.
Table 1
Table 1 shows how compound interest creates wealth. The example below shows the growth of a one-time investment of $1,000 at 10% interest, compounded annually, for 25 years. The investment is started at the beginning of the year. Each successive year, the interest is calculated on the sum of the original investment (principal), plus the interest that has accrued (accumulated).
Y e a r | Principal of $1,000 & Balance at the Start of Each Year in $ | 10% Interest Compounded Annually in $ (10% = 0.10) | Increasing Principal Base in $ (Interest is Calculated on the Sum of the Original Investment, Plus the Accrued Interest.) |
1 | 1,000.00 | 1,000.00 x 0.10 = 100.00 | 1,000.00 + 100.00 = 1,100.00 |
2 | 1,100.00 | 1,100.00 x 0.10 = 110.00 | 1,100.00 + 110.00 = 1,210.00 |
3 | 1,210.00 | 1,210.00 x 0.10 = 121.00 | 1,210.00 + 121.00 = 1,331.00 |
4 | 1,331.00 | 1,331.00 x 0.10 = 133.10 | 1,331.00 + 133.10 = 1,464.10 |
5 | 1,464.10 | 1,464.10 x 0.10 = 146.41 | 1,464.10 + 146.41 = 1,610.51 |
6 | 1,610.51 | 1,610.51 x 0.10 = 161.05 | 1,610.51 + 161.05 = 1,771.56 |
7 | 1,771.56 | 1,771.56 x 0.10 = 177.16 | 1,771.56 + 177.16 = 1,948.72* |
*The original principal doubles between Year 7 & 8 per Rule of 72. According to the Rule of 72, money doubles in about 7.2 years at 10% interest, compounded annually. (See Page ???)
8 | 1,948.72 | 1,948.72 x 0.10 = 194.87 | 1,948.72 + 194.87 = 2,143.59 |
9 | 2,143.59 | 2,143.59 x .010 = 214.36 | 2,143.59 + 214.36 = 2,357.95 |
10 | 2,357.95 | 2,357.95 x 0.10 = 235.79 | 2,357.95 + 235.79 = 2,593.74 |
11 | 2,593.74 | 2,593.74 x .010 = 259.37 | 2,593.74 + 259.37 = 2,853.11 |
12 | 2,853.11 | 2,853.11 x .010 = 285.31 | 2,853.11 + 285.31 = 3,138.42 |
13 | 3,138.42 | 3,138.42 x 0.10 = 313.84 | 3,138.42 + 313.84 = 3,452.26 |
14 | 3,452.26 | 3,452.26 x 0.10 = 345.23 | 3,452.26 + 345.23 = 3,797.49** |
** The original principal quadruples between Year 14 & 15 per Rule of 72.
15 | 3,797.49 | 3,797.49 x 0.10 = 379.75 | 3,797.49 + 379.75 = 4,177.24 |
22 | 7,400.24 | 7,400.24 x 0.10 = 740.02 | 7,400.24 + 740.02 = 8,140.26 |
23 | 8,140.26 | 8,140.26 x 0.10 = 814.03 | 8,140.26 + 814.03 = 8,954.29 |
24 | 8,954.29 | 8,954.29 x 0.10 = 895.43*** | 8,954.29 + 895.43 = 9,849.72 |
*** The compound interest approximately equals the original principal of $1,000 between Year 24 & 25. Although the build up of interest took roughly 24.5 years to match the original principal, the interest will double the original principal in the next 7.2 years per Rule of 72.
25 | 9,849.72 | 9,849.72 x 0.10 = 984.97 | 9,849.72 + 984.97 = 10,834.69 |
NOTE: The reinvestment of investment earnings is the essential step for exponential growth of the initial investment. Reinvestment makes a big difference in the investment outcome over a period of time. Eventually, reinvested earnings can grow so huge that the earnings create more earnings than the initial investment and, in turn, these earnings create even more earnings.
Difference between simple and compound Interest
Table 2
Table 2 shows the difference in the end values of a one-time investment of $1,000 invested at both 10% simple interest and 10% interest, compounded annually. Both investments are started at the beginning of the year and the duration of the investment is 8 years.
SIMPLE INTEREST $1,000 x 0.10 = $100 Per Year | COMPOUND INTEREST COMPOUNDED ANNUALLY See Table 1, Column 3 for Calculations |
Y e a r | One-Time Investment in $ | 10% in $ (10% = 0.10) | End Values in $ | One-Time Investment in $ | 10% in $ (10% = 0.10) | End Values in $ |
1 | 1,000 | 100 | 1,100 | 1,000 | 100.00 | 1,100.00 |
2 | 1,000 | 100 | 1,200 | 1,000 | 110.00 | 1,210.00 |
3 | 1,000 | 100 | 1,300 | 1,000 | 121.00 | 1,331.00 |
4 | 1,000 | 100 | 1,400 | 1,000 | 133.10 | 1,464.10 |
5 | 1,000 | 100 | 1,500 | 1,000 | 146.41 | 1,610.51 |
6 | 1,000 | 100 | 1,600 | 1,000 | 161.05 | 1,771.56 |
7 | 1,000 | 100 | 1,700 | 1,000 | 177.16 | 1,948.72 |
8 | 1,000 | 100 | 1,800 | 1,000 | 194.87 | 2,143.59 |
At the end of 8 years, a one-time investment of $1,000.00 will earn $1,800.00 with a simple interest rate of 10% and $2,143.59 with an interest rate of 10%, compounded annually. The interest earned is $343.59 more at the compounded rate. Reminder: The difference in the interest earned would be greater if the interest was compounded at a more frequent rate (e.g., daily, weekly, monthly, etc.).
Rule of 72
Einstein’s Rule of 72 is considered one of the most important investment tools ever formulated. To calculate how soon and/or at what interest rate one’s investment money will double by POC, the Rule of 72 is a simple formula to use.
Table 3
Table 3 shows how to apply the Rule of 72 to calculate the number of years required to double an investment.
· 72 is the fixed number.
· 72 is divided by the interest rate.
TO FIND THE NUMBER OF YEARS REQUIRED FOR AN INVESTMENT TO DOUBLE |
72 = Number of Years Required for an Investment to Double |
Question: If an investor earns 8% interest, compounded annually, how many years are required for his/her investment to double?
Answer: To calculate the number of years required for the investment to double, divide 72 by 8. The answer is 9 years.
Table 4
Table 4 shows how to apply the Rule of 72 to calculate the interest rate required to double an investment in a specified number of years.
· 72 is the fixed number.
· 72 is divided by the number of years.
TO FIND THE INTEREST RATE REQUIRED FOR AN INVESTMENT TO DOUBLE |
72 = Interest Rate Required to Double an Investment Number of Years in a Specified Number of Years |
Question: If an investor wants to double his/her money in 5 years, what interest rate is required?
Answer: To calculate the interest rate required, the investor would divide 72 by 5. The answer is 14.4%
Calculation of Compounding by Rule of 72
Vs.
Actual Value Calculated by Computerized Compound Interest Calculator
Table 5
Table 5 shows the difference in the end values of a one-time investment of $10,000 (in 9-year increments), using the Rule of 72* vs. using a computerized compound interest calculator.** In both examples, the interest rate is 8%, compounded annually, and the duration of the investment is 54 years.
Year | Rule of 72 in $ | Computerized Calculations in $ |
0 | 10,000 | 10,000.00 |
9 | 20,000 | 19,990.05 |
18 | 40,000 | 39,960.19 |
27 | 80,000 | 79,880.61 |
36 | 160,000 | 159,681.72 |
45 | 320,000 | 319,204.49 |
54 | 640,000 | 638,091.26 |
Note: The values in the above table differ only slightly between the two methods of calculation used. The Rule of 72 is a reliable tool for investment purposes, as long as the interest rate is less than about 20%. At higher interest rates, significant errors occur.
*moneychimp. Rule of 72 calculator. http://www.moneychimp.com/features/rule72.htm
**1728 Software Systems’ Compound Interest Calculator. [Computerized]
http://www.1728.com/compint.htm
Starting Time of Investment & POC
How does time affect POC? Starting Early vs. Starting
Late
Table 6
Table 6 shows the difference in the end values of an investment based on the starting times. Person A invests $2,000/year for 10 years, starting at Age 0 and ending at Age 10. From Age 10 to Age 65, the money is left to grow on its own. Person B invests $2,000/year for 55 years, starting at Age 10 and ending at Age 65. In both examples, the interest rate is 10%, compounded monthly.
| Person A | | Person B | |
Age | Annual Investment in $ | Year-End Values in $ 10% Compounded Monthly | Annual Investment in $ | Year End Values in $ 10% Compounded Monthly |
0 | 2,000 | 2,209.43 | 0 | 0 |
1 | 2,000 | 4,440.79 | 0 | 0 |
2 | 2,000 | 6,905.80 | 0 | 0 |
3 | 2,000 | 9,628.93 | 0 | 0 |
4 | 2,000 | 12,637.20 | 0 | 0 |
5 | 2,000 | 15,960.48 | 0 | 0 |
6 | 2,000 | 19,631.75 | 0 | 0 |
7 | 2,000 | 23,687.45 | 0 | 0 |
8 | 2,000 | 28,167.84 | 0 | 0 |
9 | 2,000 | 33,117.38 | 0 | 0 |
10 | 0 | 36,585.20 | 2,000 | 2,209.43 |
11 | 0 | 40,416.15 | 2,000 | 4,440.79 |
12 | 0 | 44,648.25 | 2,000 | 6,905.80 |
13 | 0 | 49,323.51 | 2,000 | 9,628.93 |
14 | 0 | 54,488.33 | 2,000 | 12,637.20 |
15 | 0 | 60,193.97 | 2,000 | 15,960.48 |
16 | 0 | 66,497.07 | 2,000 | 19,631.75 |
17 | 0 | 73,460.18 | 2,000 | 23,687.45 |
18 | 0 | 81,152.42 | 2,000 | 28,167.84 |
19 | 0 | 89,650.14* | 2,000** | 33,117.38*** |
*Reinvestment of investment earnings can make a big difference in investment results over time. Reinvested earnings may generate more earnings and those earnings, in turn, can generate even more earnings.
**Although Person A has not made any contributions in 10 years, Person B will never be able to catch up because Person A was earning compound interest monthly for 10 years before Person B started investing. At the end of Year 19, Person A has earned $___________ in compound interest on his/her investment, which is $______ more than Person B’s $2,000 yearly contribution, plus $__________ compound interest.
***The significant difference in the year-end values of the two investments at Year 19 clearly indicate that the sooner a person begins to save, the less money he/she may need to put away over time in order to reach his/her investment goals.
20 | 0 | 99,037.68 | 2,000 | 38,585.20 |
21 | 0 | 109,408.22 | 2,000 | 44,625.57 |
22 | 0 | 120,864.69 | 2,000 | 51,298.45 |
23 | 0 | 133,520.80 | 2,000 | 58,670.07 |
24 | 0 | 147,502.17 | 2,000 | 66,813.59 |
25 | 0 | 162,947.57 | 2,000 | 75,809.85 |
26 | 0 | 180,010.31 | 2,000 | 85,748.13 |
27 | 0 | 198,859.74 | 2,000 | 96,727.08 |
28 | 0 | 219,682.95 | 2,000 | 108,855.67 |
29 | 0 | 242,686.63 | 2,000 | 122,254.28 |
30 | 0 | 268,099.09 | 2,000 | 137,055.90 |
31 | 0 | 296,172.57 | 2,000 | 153,407.44 |
32 | 0 | 327,185.71 | 2,000 | 171,471.20 |
33 | 0 | 361,446.33 | 2,000 | 191,426.48 |
34 | 0 | 399,294.48 | 2,000 | 213,471.33 |
35 | 0 | 441,105.83 | 2,000 | 237,824.57 |
36 | 0 | 487,295.37 | 2,000 | 264,727.91 |
37 | 0 | 538,321.56 | 2,000 | 294,448.38 |
38 | 0 | 594,690.86 | 2,000 | 327,280.97 |
39 | 0 | 656,962.76 | 2,000 | 363,551.56 |
40 | 0 | 725,755.35 | 2,000 | 403,620.16 |
41 | 0 | 801,751.42 | 2,000 | 447,884.47 |
42 | 0 | 885,705.27 | 2,000 | 496,783.83 |
43 | 0 | 978,450.19 | 2,000 | 550,803.59 |
44 | 0 | 1,080,906.71 | 2,000 | 610,479.92 |
45 | 0 | 1,194,091.77 | 2,000 | 676,405.15 |
46 | 0 | 1,319,128.78 | 2,000 | 749,233.61 |
47 | 0 | 1,457,258.80 | 2,000 | 829,688.16 |
48 | 0 | 1,609,852.84 | 2,000 | 918,567.35 |
49 | 0 | 1,778,425.47 | 2,000 | 1,016,753.35 |
50 | 0 | 1,964,649.86 | 2,000 | 1,125,220.71 |
51 | 0 | 2,170,374.37 | 2,000 | 1,245,046.02 |
52 | 0 | 2,397,640.93 | 2,000 | 1,377,418.61 |
53 | 0 | 2,648,705.27 | 2,000 | 1,523,652.34 |
54 | 0 | 2,926,059.32 | 2,000 | 1,685,198.65 |
55 | 0 | 3,232,455.97 | 2,000 | 1,863,660.97 |
56 | 0 | 3,570,936.35 | 2,000 | 2,060,810.63 |
57 | 0 | 3,944,860.05 | 2,000 | 2,278,604.43 |
58 | 0 | 4,357,938.45 | 2,000 | 2,519,204.09 |
59 | 0 | 4,814,271.55 | 2,000 | 2,784,997.68 |
60 | 0 | 5,318,388.69 | 2,000 | 3,078,623.33 |
61 | 0 | 5,875,293.48 | 2,000 | 3,402,995.42 |
62 | 0 | 6,490,513.48 | 2,000 | 3,761,333.51 |
63 | 0 | 7,170,155.06 | 2,000 | 4,157,194.28 |
64 | 0 | 7,920,963.99* | 2,000 | 4,594,506.85** |
*Person A’s total 10-year contribution of $20,000 ($2,000/year from Age 0 to the end of Age 9) is worth $7,920,963.99 at Age 65.
** In comparison, Person B’s total 55-year contribution of $110,000 ($2,000/year from the beginning of Year 10 to the end of Year 64) is worth $4,594,506.85 at Age 65. Over the years, the difference in the two investments grows much greater in favor of Person A.
Clearly, Person B started 10 years too late. Imagine how much greater the difference would have been if Person A had continued to invest to Year 65, instead of stopping. The year end values in Table 6 above are perfect proof of the power of compounding.
Table 7
Table 7 shows another example of the difference in the end values of an investment based on the starting times. Person A invests $2,000/year for 10 years, starting at Age 25 and ending at Age 35. From Age 35 to Age 65, the money is left to grow on its own. Person B invests $2,000/year for 30 years, starting at Age 35 and ending at Age 65. In both examples, the interest rate is 10%, compounded monthly.
| Person A | | Person B | |
Age | Annual Investment in $ | Year-End Values in $ 10% Compounded Monthly | Annual Investment in $ | Year End Values in $ 10% Compounded Monthly |
25 | 2,000 | 2,209.43 | 0 | 0 |
26 | 2,000 | 4,440.79 | 0 | 0 |
27 | 2,000 | 6,905.80 | 0 | 0 |
28 | 2,000 | 9,628.93 | 0 | 0 |
29 | 2,000 | 12,637.20 | 0 | 0 |
30 | 2,000 | 15,960.48 | 0 | 0 |
31 | 2,000 | 19,631.75 | 0 | 0 |
32 | 2,000 | 23,687.45 | 0 | 0 |
33 | 2,000 | 28,167.84 | 0 | 0 |
34 | 2,000 | 33,117.38 | 0 | 0 |
35 | 0 | 36,585.20 | 2,000 | 2,209.43 |
36 | 0 | 40,416.15 | 2,000 | 4,440.79 |
37 | 0 | 44,648.25 | 2,000 | 6,905.80 |
38 | 0 | 49,323.51 | 2,000 | 9,628.93 |
39 | 0 | 54,488.33 | 2,000 | 12,637.20 |
40 | 0 | 60,193.97 | 2,000 | 15,960.48 |
41 | 0 | 66,497.07 | 2,000 | 19,631.75 |
42 | 0 | 73,460.18 | 2,000 | 23,687.45 |
43 | 0 | 81,152.42 | 2,000 | 28,167.84 |
44 | 0 | 89,650.14 | 2,000 | 33,117.38 |
45 | 0 | 99,037.68 | 2,000 | 38,585.20 |
46 | 0 | 109,408.22 | 2,000 | 44,625.57 |
47 | 0 | 120,864.69 | 2,000 | 51,298.45 |
48 | 0 | 133,520.80 | 2,000 | 58,670.07 |
49 | 0 | 147,502.17 | 2,000 | 66,813.59 |
50 | 0 | 162,947.57 | 2,000 | 75,809.85 |
51 | 0 | 180,010.31 | 2,000 | 85,748.13 |
52 | 0 | 198,859.74 | 2,000 | 96,727.08 |
53 | 0 | 219,682.95 | 2,000 | 108,855.67 |
54 | 0 | 242,686.63 | 2,000 | 122,254.28 |
55 | 0 | 268,099.09 | 2,000 | 137,055.90 |
56 | 0 | 296,172.57 | 2,000 | 153,407.44 |
57 | 0 | 327,185.71 | 2,000 | 171,471.20 |
58 | 0 | 361,446.33 | 2,000 | 191,426.48 |
59 | 0 | 399,294.48 | 2,000 | 213,471.33 |
60 | 0 | 441,105.83 | 2,000 | 237,824.57 |
61 | 0 | 487,295.37 | 2,000 | 264,727.91 |
62 | 0 | 538,321.56 | 2,000 | 294,448.38 |
63 | 0 | 594,690.86 | 2,000 | 327,280.97 |
64 | 0 | 656,962.76* | 2,000 | 363,551.56** |
*Person A’s total 10-year contribution of $20,000 ($2,000/year from the beginning of Age 25 to the end of Age 34) is worth $656,962.76 at Age 65.
** In comparison, Person B’s total 30-year contribution of $60,000 ($2,000/year from the beginning of Year 34 to the end of Year 64) is worth $363,551.56 at Age 65. As in Table 6 above, the difference in the two investments over the years grows much greater in favor of Person A.
Again, the earlier that money is placed into an investment the more time there is for POC is work a miracle. Time is money…and, although money does not guarantee happiness, money does provide options not otherwise available.
Table 8
Table 8 is a recap of Tables 6 & 7 above. Recall, all totals shown below were calculated based on an interest rate of 10%, compounded monthly.
Recap | Person A Table 6 | Person B Table 6 | Person A Table 7 | Person B Table 7 |
Year | Yearly Deposit of $2,000 from Age 0 to Age 10 (10-Year Total of $20,000) | Yearly Deposit of $2,000 from Age 10 to Age 65 (55-Year Total of $110,000) | Yearly Deposit of $2,000 from Age 25 to Age 35 (10-Year Total of $20,000) | Yearly Deposit of $2,000 from Age 35 to Age 65 (30-Year Total of $60,000) |
0 | 2,209.43 | 0 | 0 | 0 |
9 | 33,117.38 | 0 | 0 | 0 |
10 | 36,585.20 | 2,209.43 | 0 | 0 |
19 | 89,650.14 | 33,117.38 | 0 | 0 |
24 | 147,502.17 | 66,813.59 | 0 | 0 |
25 | 162,947.57 | 75,809.85 | 2,209.43 | 0 |
29 | 242,686.63 | 122,254.28 | 12,637.20 | 0 |
34 | 399,294.48 | 213,471.33 | 33,117.38 | 0 |
35 | 441,105.83 | 237,824.57 | 36,585.20 | 2,209.43 |
39 | 656,962.76 | 363,551.56 | 54,488.33 | 12,637.20 |
49 | 1,778,425.47 | 1,016,753.35 | 147,502.17 | 66,813.59 |
54 | 2,926,059.32 | 1,685,198.65 | 242,686.63 | 122,254.28 |
59 | 4,814,271.55 | 2,784,997.68 | 399,294.48 | 213,471.33 |
64 | 7,920,963.99 | 4,594,506.85 | 656,962.76 | 363,551.56 |
Suggested reading: The Power of Compounding. Safer Child, Inc.
http://www.saferchild.org/power.htm
Note: Calculations for Tables 6 to 8 were computed using FundAdvise.com online calculator at About.com http://www.saferchild.org/power.htm
http://mutualfunds.about.com/gi/dynamic/offsite.htm?zi=1/XJ&sdn=mutualfunds&cdn=money&tm=264&gps=99_1092_1020_587&f
=11&su=p649.0.147.ip_p284.5.420.ip_&tt=2&bt=1&bts=0&zu=http%3A//
www.tcalc.com/tvwww.dll%3FSave%3FCstm%3Dfundadvice%26IsAdv%3
D0%26SlvFr%3D6
Table 9
Table 9 shows the number of years necessary for a one-time investment (in $1,200 increments) to become $1 million dollars at 10% interest, compounded at various frequencies (daily, weekly, and annually). For all three examples, the investment is started at the beginning of the year.
ONE-TIME Investment in $ Started at the Beginning of the Year | Number of Years To Become $1 Million at 10% Compounded Daily | Number of Years To Become $1 Million at 10% Compounded Monthly | Number of Years To Become $1 Million at 10% Compounded Annually |
1,200 | 67.2635 | 67.5342 | 70.5636 |
2,400 | 60.3311 | 60.5739 | 63.2911 |
3,600 | 56.2759 | 56.5023 | 59.0369 |
4,800 | 53.3987 | 53.6136 | 56.0186 |
6,000 | 51.167 | 51.3728 | 53.6773 |
7,200 | 49.3435 | 49.542 | 51.7644 |
8,400 | 47.8018 | 47.9941 | 50.147 |
9,600 | 46.4663 | 46.6532 | 48.746 |
10,800 | 45.2883 | 45.4705 | 47.5102 |
12.000 | 44.2345 | 44.4125 | 46.4048 |
13,200 | 43.2813 | 43.4554 | 45.4048 |
14,400 | 42.4111 | 42.5817 | 44.4919 |
15,600 | 41.6105 | 41.778 | 43.652 |
16,800 | 40.8694 | 41.0338 | 42.8745 |
18,000 | 40.1793 | 40.341 | 42.1506 |
19,200 | 39.5339 | 39.6929 | 41.4735 |
20,400 | 38.9275 | 39.0842 | 40.8374 |
21,600 | 38.3559 | 38.5102 | 40.2377 |
22,800 | 37.8151 | 37.9673 | 39.6704 |
24,000 | 37.3021 | 37.4522 | 39.1322 |
25,200 | 36.8142 | 36.9623 | 38.6203 |
26,400 | 36.3489 | 36.4951 | 38.1322 |
27,600 | 35.9043 | 36.0488 | 37.6659 |
28,800 | 35.4787 | 35.6214 | 37.2193 |
30,000 | 35.0704 | 35.2115 | 36.791 |
40,000 | 32.1932 | 32.3227 | 33.77 |
50,000 | 29.9614 | 30.082 | 31.43 |
60,000 | 28.138 | 28.2512 | 29.519 |
70,000 | 26.5962 | 26.7032 | 27.90 |
80,000 | 25.2607 | 25.3624 | 26.50 |
90,000 | 24.0828 | 24.1796 | 25.26 |
100,000 | 23.029 | 23.1217 | 24.16 |
Calculations for Table 9 were done using 1728 Software Systems' Compound Interest Calculator. http://www.1728.com/compint.htm. Note: The resultant years are very close to values obtained by Rule of 72.
Table 10
Table 10 shows the end values of a one-time investment of $20,000 at 10% interest, compounded annually, in 10-year increments. For all examples, the investment is started at the beginning of the year.
Amount One-Time Investment in $ Started at the Beginning of the Year | Year | Year end value End Values in $ 10% Interest Compounded Annually |
20,000 | 1 | 22,000.00 |
| 10 | 51,875.00 |
| 20 20 | 134,550.00 |
| 30 30 | 348,988.00 |
| 40 40 | 905,185.11 |
| 50 50 | 2,347,817.06 |
Calculations are done using 1728 Software Systems' Compound Interest Calculator. http://www.1728.com/compint.htm.
Table 11
Table 11 shows the end values of a monthly investment, ranging from $500 to $10,000, at 10% interest, compounded monthly, for 10 years.
Monthly Investment in $ for a Total of 10 Years | End Values in $ 10% Interest Compounded Monthly |
500 | 103,776.01 |
1,000 | 207,552.02 |
2,000 | 415,104.04 |
3,000 | 622,656.06 |
4,000 | 830,208.08 |
5,000 | 1,037,760.10 |
6,000 | 1,245,312.12 |
7,000 | 1,452,864.14 |
8,000 | 1,660,416.16 |
9,000 | 1,867,968.18 |
10,000 | 2,075,520.20 |
When planning for retirement, the shrewd investor will take into account the future purchasing power of his/her money. According to Investopedia… A simple way to think about purchasing power is to imagine if you made the same salary as your grandfather. Clearly you could survive on much less a few generations ago, however, because of inflation; you'd need a greater salary just to maintain the same quality of living.
Investopedia. Purchasing Power: What does it mean?http://www.investopedia.com/terms/p/purchasingpower.asp
"It's been said that a dollar doesn't buy what it used to. What about 20 years from now? Money Magazine's Walter Updegrave shows you how to shield your nest egg."
Suggested Reading: CNNMoney.com. Retirement: The inflation threat by Walter Updegrave, Money Magazine senior editor. November 2, 2007: 4:56 PM EDT. http://money.cnn.com/2007/10/04/pf/expert/expert.moneymag/index.htm
Suggested Reading: CNNMoney.com. Retirement: The inflation threat by Walter Updegrave, Money Magazine senior editor. November 2, 2007: 4:56 PM EDT.
http://money.cnn.com/2007/10/04/pf/expert/expert.moneymag/index.htm
Table 12
Table 12 shows the percent of pre-tax salary an individual would need to invest annually in a Retirement Fund if he/she wants to retire on 80 percent of his/her last year's salary before retiring at Age 65.
Starting Age of Investor | Starting with 6 Months’ Salary Saved* | % of Pre-Tax Salary** Needed to Invest Annually in a Retirement Fund to Retire on 80% of Last Year’s Salary Before Retiring at Age 65 |
25 | 6 months | 3 % of pre-tax salary |
45 | 6 months | 18 % of pre-tax salary |
50 | 6 months | 28 % of pre-tax salary |
55 | 6 months | 50 % of pre-tax salary |
* Example of 6 Months’ Salary Saved: If a person earns $60,000/year, the % of pre-tax salary that he/she would have saved in 6 months is $30,000 ($60,000 divided by 12 months = $5,000/month earnings x 6 months = $30,000 savings).
** Examples of % of Pre-Tax Salary an individual would need to save annually, starting with 6 months’ salary saved:
3% of Pre-Tax Salary annually at Age 25: $60,000/year salary = $1,800 ($60,000 x .03 = $1,800)
18% of Pre-Tax Salary annually at Age 45: $60,000/year salary = $10,800 ($60,000 x .18 = $10,800)
28% of Pre-Tax Salary annually at Age 50: $60,000/year salary = $16,800 ($60,000 x .28 + $16,800)
50% of Pre-Tax Salary annually at Age 55: $60,000/year salary = $30,000 ($60,000 x .50 = $30,000)
In the words of Ben Stein…
If you start at 25 with six months' salary saved, you need only save 3 percent of your total, pre-tax salary per year to get the nest egg you need (roughly 15 times earnings at retirement) by age 65. But if you start at age 45, you need to save 18 percent of your salary (again, assuming you start out with six months' of salary saved). If you start at age 50, you need to save 28 percent of your salary. And if you start at age 55, you need to save nearly 50 percent of your gross salary to get where you need to be.
Source:
How to Retire Rich: Use the Power of Compounding. Ben Stein. October 10, 2005. http://www.freemoneyfinance.com/2005/10/how_to_retire_r.html
In her article "What You Don’t Know Can Hurt You Financially," author and journalist Laura Rowley states, "Financial literacy matters because it influences decision-making, and there is a very strong link between financial literacy and your debt behavior, wealth accumulation, and retirement planning." Rowley cites Charles J. Farrell’s (a financial planner with Colorado’s Northstar Investment Advisors, LLC) suggestion for how an individual may keep his/her options open in retirement.
Farrell proposes that a person put a number on his/her ultimate financial goal for retirement. By age 65, Farrell suggests: "…have 12 times your then-current pay stashed away." For example, if a person earns $100,000 in his/her last year of work, he/she would need to have $1.2 million dollars in savings ($100,000 x 12 = $1.2 million). The person would then have $60,000/year to spend during retirement, if he/she withdraws 5 percent per year ($1.2 million x .05 = $60,000).
According to a study by Hewitt Associates, a human resources consulting firm:
Women live an average of 22 years after retirement versus 19 years for men, and medical costs are rising, so women will need to save 2 percent more than men every year over 30 years to maintain their standard of living upon retirement…[Women] start saving later (by two to four years), invest less (7.3 percent versus 8.1 percent) and are in and out of the work force more often for family reasons - gaps that can result in hundreds of thousands of dollars in missed earnings, raises and benefits…If a woman who earns $57,000 a year boosts her contribution from 2 percent to 4 percent - an extra $95 a month - she can save an extra $81,000 by the time she retires…That doesn't include her employer's matching contribution.
Source: Women live longer but aren’t saving enough for it. July 18, 2008. baltimoresun.com http://www.baltimoresun.com/business/investing/bal-bz.women10jul10,0,7727807.story
Table 13
Table 13 shows the age an individual would need to start investing and the corresponding percent of his/her annual pre-tax income that would need to be saved to reach a specific financial goal for retirement.
Starting Age of Investor in Years | Annual Pre-Tax Income Saved in % |
20 | 5 |
30 | 10 |
40 | 15 |
50 | 20 |
Farrell further suggests, "If the recommended percentage is beyond your budget, start saving 1 percent today, and add a percent each year – 2 percent in year two, 3 percent in year three, and so on, until you reach your goal."
Source: YAHOO! FINANCE. What You Don’t Know Can Hurt You Financially by Laura Rowley. Posted on Wednesday, March 5, 2008, 12:00 AM. http://finance.yahoo.com/expert/article/moneyhappy/70114
Table 14
Table 14 shows the monthly investment necessary to accumulate $1 million dollars by Age 65, starting at various ages. In all examples, the amount of prior savings is indicated, and a comparison is made between interest rates of 10% and 8%, compounded monthly.
Age | Prior Savings in $ | Amount Needed* to Invest Monthly to Accumulate $1 Million by Age 65 at 10% Interest Compounded Monthly | Amount Needed* to Invest Monthly to Accumulate $1 Million by Age 65 at 8% Interest Compounded Monthly |
0 | 0 | 19.10 | 52.00 |
10 | 0 | 31.50 | 77.25 |
25 | 0 | 141.75 | 262.00 |
35 | 0 | 395.00 | 611.00 |
35 | 50,000 | 0 | 251.00 |
45 | 0 | 1,164.00 | 1,525.25 |
45 | 50,000 | 700.00 | 1,128.00 |
45 | 100,000 | 224.00 | 718.00 |
55 | 0 | 4,150.00 | 4,700.00 |
55 | 50,000 | 3,575.00 | 4,200.00 |
55 | 100,000 | 2,935.00 | 3,625.00 |
55 | 200,000 | 1,685.00 | 2,475.00 |
*Approximate values
Source: YAHOO! FINANCE. How to Make a Million by Mary Beth Franklin. Tuesday, January 22, 2008. Provided by Kiplinger.com. http://finance.yahoo.com/focus-retirement/article/104258/How-to-Make-a-Million?mod=retirement-preparation
The difference between starting early and starting late when investing makes a huge difference in the outcome of the investment as shown in Tables 6 through 14 above. Time is the most important and indispensable factor for wealth creation. A person needs to start investing early (i.e., at Age 0) to allow enough time for POC to build wealth. If a person starts later in life, the need to invest larger amounts would be necessary to make up for lost time. A higher rate of return would also help to increase earnings.
In addition to having the knowledge that starting early is the best option for building wealth, an individual may also derive some benefit from knowing the "relative value" of an amount of money in one year compared to another. Six ways to compute the relative value of a U. S. dollar amount from 1774 to present can be found at measuringworth.com. An example of other information that is available on the Website is presented below:
How much would your saving grow in the past, depending on what it is invested in?
One's saving accumulates over time at different rates depending on where it is invested. Saving accounts at banks are very safe; however, they pay a low rate of return compared to the stock market. Bonds can pay more, but sometimes require investors to keep their money tied up for extended periods. Stocks are usually the most risky and for many periods have given their owners high returns; however, they can go through long periods of no appreciation, such as from 1965 to 1982 in the United States. The saving calculator can tell you how your savings would have grown in the past depending on which type of asset you chose.
Source: MEASURINGWORTH. Purchasing Power of Money in the United States from 1774 to 2007. http://www.measuringworth.com/ppowerus/result.php
The MeasuringWorth calculators allow the user to calculate how much money a person would need in the year 2007 to have the same purchasing power of one dollar in the year 1774 and 1952, respectively, as shown below:
"$26.51 in the year 2007 has the same purchase power as $1 in the year 1774."
"$7.81 in the year 2007 has the same purchase power as $1 in the year 1952."
Source: http://www.measuringworth.com/ppowerus/
To summarize: Since 1774, one dollar has lost about 20% of it’s value in 100 years, 89% of its value in 200 years, 97% of it’s value in 234 years, and about 90% of its value in last 50 years (between 1952 to 2007).