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~The "Secrets" to Growing Wealth:  The Power of 1%~

 

For Math teachers these concepts might be obvious, but to the rest of us, maybe not so much. 

 

Take a look at the table below that I came across on a financial website (https://tciwealth.com/featured-post/the-power-of-time/)

 

It's an easy way to grasp a couple of important investing principles:

 

 

First, compare the green cells.  You'll see something obvious.  When the monthly investment doubles from $500 to $1000, the final sum also doubles from $90k to $180k.  Nothing surprising.

 

Next, the yellow cells.  One person invests $100 a month over 40 years at 7%, which yields $260k.  The other person waits 20 years so they now have half as many years to invest for retirement.  But, they must more than double their monthly investment to still reach the $260k - they must instead quintuple their investment to still reach $260k.

 

Lastly, consider the turquoise cells.  The only difference here is that one person is earning 8% on their investment and the other person is earning 9%.  One percent doesn't seem like much.  However, the difference over 40 years is very significant - a million dollars.

 

Though you might find all of this depressing, there is a lot of good news here.  First, even if you can only invest a relatively small amount each month, if you (or your child) can start doing that early, compounding can help in a big way.  Secondly, even if one started investing late, you can see that the power of 1% is very significant.  So if one can find a way to increase returns by 1%, it is possible to make up for some of the effect of that later start.

 

So, how can one get an extra 1% on one's investments?  Here are a few potential ways.

 

• Fees on investment funds:  check the fees on your mutual funds and consider sticking with what are called "index funds".  This type of fund doesn't have a conventional manager who is paid for adjusting the mix of the investments; instead, the fund is invested in a "fixed" index (like the S&P 500) and is only adjusted when the index changes.  Fees on managed funds can be well over 1%, while the lowest fees on index funds can be less than .05%.  The good news is also that, historically, index funds have beaten managed funds, even when the returns are adjusted for risk.  

• Fees paid to a traditional financial advisor:  I can write more about traditional financial advisors in another post, but traditional financial advisors generally charge between 1% to 2% of your invested assets.  If you don't need this person or you can find sound investment advice for a fixed fee (like at Educated Investors), there's your 1% (at least).  Or you can use a "robo advisor" at a firm like Fidelity or Vanguard, which charge less than .4%.

• Consider your asset allocation:  From 1930 to 2019, these are the compounded rates of return on the following assets (keep in mind that this time period includes the Great Depression):

  • US S&P 500 stocks:  9.8% (about 6.8% after inflation)

  • US stocks of small, cheap companies (aka "small-cap value):  13.7% (10.7% after inflation)

  • US long-term government bonds:  5.7% (2.7% after inflation)

  • US short-term government bonds (similar to a savings account):  3.3% (.3 % after inflation

 

We don't know if the results above will continue into the future (and over the past decade or so the S&P 500 has significantly outperformed small, cheap companies) but the past results at least provide a sense of what has been possible historically and might provide guidance for creating a diversified and appropriate portfolio to meet an investor's individual needs.

 

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April 26, 2023