I have a really nice $820 top hat. It wasn't always worth $820, yet with the magic often associated with top hats, it could be worth $3,280 when I retire. Actually, I'm fooling myself. I'd be lucky to sell it for more than $50. No magic there. The real magic is something called compound interest. If you understand how it works when you are young, you will be much better prepared for retirement.
While in college, I had a summer job in Anaheim, California. I made sure I visited Disneyland soon after I got there. While mouse ears are the headgear of choice at Disneyland, I was attracted to the fine hats on display at a haberdashery store in the park. With the rashness of youth, I paid $30 for a very nice top hat, thinking it would help me stand out as one of the classier students on campus. Scientists have since determined that the human brain is not fully developed until age 25, and my decision to buy the hat was proof of it. When I came back to school my roommates, after picking themselves off of the floor where they had been rolling around laughing, explained to me that wearing the top hat around campus would not make me look classy, but rather like a clueless nerd. This was not the England of the 1880s it was the U.S.A. of the 1980s. So for most of the last 31 years, this fine hat has mostly remained in a hat box.
With the perspective of three decades of experience, I wish I had a "Back to the Future DeLorean car" I could use to visit my younger self and talk him into forgoing the $30 hat and using the money to buy a mutual fund. Mutual funds are sold by investment firms who pool the funds of thousands of investors and use them to buy dozens (if not hundreds) of stocks which are mutually owned by the investors. This spreads the risk around so the investors can benefit from stock market-level returns without the risk associated with investing everything in one stock. Turns out that if I had invested $30 in 1982 in a mutual fund indexed to the S&P 500, it would now be worth $820. Though there is no way to predict it happening, if this investment continued to grow at this historic rate, it would double in value twice in the next 13 years and reach $3,280.
This amazing growth is not really magic. It's just compound interest at work. When you let an investment grow, it builds like a rolling snowball, a little at first, but more and more as the snowball grows bigger. Time is the most important part of putting compound interest to work for you. Start early enough and you can end up with a massive snowball.
I am not going to find a time travelling Back to the Future DeLorean, but I can change the future if I can get more and more people in their twenties to make it a habit to start saving for retirement early. For example, what if you decide to forego that $100 pair of jeans and instead use the money to buy a mutual fund? What will the difference be after 50 years? In the case of the jeans, they likely will no longer fit. But the mutual fund purchased for $100 could grow to a thousand dollars or more.
When some people think of investing in stocks or mutual funds, they mistakenly assume it is only for rich people. That is not true. Many brokerage firms will open an Individual Retirement Account (IRA) for $250, or sometimes even less. The hard part may be deciding which mutual funds are the best for you. There are thousands to choose from, and in any given year some do better than average, and some do worse than average. Many experts recommend that instead of trying to pick a winning mutual fund, you choose an indexed mutual fund that will give you the average return for the index you choose (such as the S&P 500, the Russell 2500 and the FTSE 100). Over the long haul, by definition, there is no risk of being saddled with a below average return with an indexed mutual fund, so more of your money grows from year to year.
Obviously this advice has the most value to younger people. (Hint, this is where you hit the "share" button.) But the concept of foregoing some purchases and using the money to invest for retirement works at any age. Your money should still grow - just not as much. Your other option is find some value for the things you purchased in your youth once you reach retirement age. Pass the salt - I'm going to eat my hat.
This article was originally published on FamilyShare.com. Check out these other related articles: How much investment risk should I take?,
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