Long-term compound interest is truly the eighth wonder of the world.
Which is a better investment: buying a home or investing in stocks?
Since 1995, stock prices have outperformed home prices by a factor of four, but which is actually the better investment for building wealth?
For those seeking financial security in retirement, there is a saying that all young people should keep in mind. “Time on the market is much more important than ‘timing the market.’ In other words, if you start early and make consistent contributions, you don’t need to invest huge sums of money to enjoy a healthy retirement.
By investing even small amounts early in your career, your small savings can benefit from compounded returns and dividends over many years. And when you put those savings into a tax-advantaged IRA or 401k plan, you can potentially earn compound interest without paying capital gains taxes.
Here’s how you can earn $1 million in retirement by investing just $6.66 a day.
stock market miracle
Over the long term, the U.S. stock market rose about 10% per year. Returns in any given year can vary wildly, from huge gains to stomach-churning declines, but those who stick with U.S. stocks over the long term do very well. This 10% return beats every other asset class, or at least every other asset class that is easily accessible to the average investor.
10% may not sound like a lot, but if your savings grow at that rate over several decades, that small amount of money can grow into a sizeable retirement nest egg.
A million dollars by the age of 65? There is no problem starting at the age of 25.
What do you get with 10% rebate? How about $1 million in retirement by investing just $6.66 per day? The calculation is simple but noteworthy. If the stock market rose at an average return of 9.62% over the next 40 years (slightly lower than the recent 30-year return of U.S. stocks), you would only need to contribute $200 per month, or about $6.66 per day, to reach $1 million.
So if you contribute $200 a month starting at age 25, or $6.66 a day, you’ll have $1 million by age 65. Total contributions over the 40-year period were only about $96,000, with the remaining $904,000 coming entirely from market gains and dividends.
Of course, this assumes that there are no tax leaks or management fees. However, these days it is now easy to invest in broad market indexes such as the S&P 500 and the Comprehensive Market Index with very low management fees. Examples include the Vanguard S&P 500 ETF and the Vanguard Total Stock Market ETF., Each tracks the S&P 500 index and the entire U.S. stock market, and each has a management fee of just 3 basis points, close to zero.
sit in the shade after retirement
Warren Buffett once said about long-term investing: “Someone is sitting in the shade today because someone planted a tree a long time ago.”
In fact, the example above shows that even with market average returns, the seeds of small daily savings can grow into a nest egg like a redwood tree.
And if an average return of just $6.66 per day turns your retirement into $1 million, just think how much easier your retirement would be if you were able to achieve above-average returns.
That’s what The Motley Fool tries to do with its foolish investment philosophy. We find the best companies, run by great managers, with significant or new competitive advantages, and hold these winning companies for the long term to allow the miracle of compound interest to work.
For example, if you were able to compound your portfolio at 12% instead of 9.6% through good stock selection, that $200 per month would add up to nearly $2 million over 40 years, double your total original return. So even if your annual returns seem to have improved slightly, compounding over many years could ultimately lead to even bigger results.
But whether you choose to invest in low-risk, low-cost index funds or pick your own stocks and hope for outperformance, the key is to invest as early as possible and continue to make regular contributions. This is especially true if your employer offers a tax-advantaged retirement plan that matches your contributions.
Billy Duberstein and/or his clients have no position in any stocks mentioned. The Motley Fool has positions in and recommends the Vanguard S&P 500 ETF and the Vanguard Total Stock Market ETF. The Motley Fool has a disclosure policy.
The Motley Fool is a USA TODAY content partner providing financial news, analysis and commentary designed to help people take control of their financial lives. Its content is produced independently of USA TODAY.
