When Does $28,000 equal $148,000?

A Tale of Two Investors

Bob is 21 years old. He starts saving money in what is called a “qualified” retirement investment, (an IRA for example). He puts away $4000 each year, without fail, until he is 28 years old. At that point he stops and never puts another dime in his account. He just lets it sit until he is 65 and plans to retire.

Dave is 21 years old. He is busy with life and things and he doesn’t save any money. Then on his 28th birthday, he realizes that he had better get with it and start saving for retirement. He starts putting $4000 each year into the exact same type of retirement investment that Bob has. He keeps making his deposits every year from age 28 until he retires at age 65.

How will it turn out for these two gentlemen? Bob has put away a total of $28,000. Dave, a total of $148,000. Who will come out on top of the retirement game? Would you be surprised if I told you that Bob would have more money?

Let’s look at what happened.

Just to keep things simple I will use a flat 10% rate of return. Now we all know that life and the world of investing doesn’t work quite like that, but for this exercise it is an easier formula to work with than a more complex algorithm and it will adequately illustrate my point.

That said, we calculate that Bob’s investment of $28,000 could grow to $1,616,310.30 by the time he reaches age 65. Meanwhile Dave’s investment of $148,000 could grow to $1,566,251.85 by the time he retires at age 65. That is a $50,000 difference. That means that in order for Dave to get essentially the same result as Bob, he has to invest $120,000 more than Bob does.

Waiting for 7 years will cost Dave more than $17,000 each of those years.

This simple illustration shows just how powerful an ally time can be when you make it your companion in your personal investment program. It also shows us the high cost of waiting.

Time and Consistency are your friends.

(Disclaimer: This is an illustration for educational purposes only and is not an attempt to project or guarantee any particular investment performance, nor is it intended to advocate any particular type of investment method or product)

A Llama Story

You decide to start a llama ranch. Your plan? Spend $100 each month buying as many llamas as you can until you get a large herd. This month llamas cost $50 each, you have $100 to spend, so you by 2 llamas.

It’s December now, time to buy more llamas. The llama market is just booming and llama prices have gone up. They cost $100 each now. January rolls around and llama prices are still at $100 each, and everyone is talking about the exciting and wonderful llama market boom we are having.

But then February brings bad news for the llama market, and in an crash that happened almost overnight, the price for llamas has plummeted to a mere $5 per llama. Everybody’s llama herd is now worth 1/20th of what it was in December and January. Now, most llama ranchers would be jumping out of windows at this point, but you are undaunted and remain focused on your goal of becoming a llama mogul, so you use the $100 you budgeted to buy more llamas.

In March, although the price has recovered a little bit, the llama market is still looking bad. Llamas are only selling for $10 each. “Onward!” you declare, and spend another $100.

April rolls around and the market is looking better. Llama prices have risen to $20 each, so you buy some more to add to your growing herd.

Now it’s May. You have had enough. Those llamas are tearing up the place and they are really smelly, so you decide to RETIRE from the llama business and sell the whole heard. The problem is that the llama market still hasn’t returned to those glorious “Boom Market” prices of last November, December and January. Right now you can only sell your llamas for $25 apiece. Oh well, I guess you can’t win them all, so off they go to the market.

Then you get your check from selling your llamas. Wait a minute! You made a profit? How’d that happen? Let’s take a closer look:
Over a six-month period you spent $100 each month purchasing llamas for a total cash outlay of $600.

You purchased llamas at various prices.

      Month         Cost                # of Llamas
                         per Llama        purchased
       Nov           $  50.00                 2
       Dec           $ 100.00                 1
       Jan            $ 100.00                 1
       Feb            $    5.00               20
       Mar           $  10.00               10
      April           $  20.00                 5

Total number of Llamas purchased: 39

In May you sold 39 llamas at $25 each for a total of $975. Subtract your original $600 investment, and you walk away with a tidy profit of $375.

Congratulations! You have just discovered the power of “Time and Consistency” coupled with the principle of “Dollar Cost Averaging”.

(Legal disclaimer: No llamas were hurt or injured in writing this story)


Next Post: When does $28,000 equal $148,000 ?

Four Ways to Earn Income

4. Investment Income, (your money earns money)

Trading time for money, (see post from Nov. 3rd), doesn’t provide the long lasting financial comfort and abundance most of us are seeking. To achieve this you must couple trading time for money with at least one other method of earning income, “Investing”.

When you invest money, you become the beneficiary of multiplication. You tap into what Einstein called “the most powerful force in the universe”, Compounding Interest. Every dollar that you have invested is a small “clone” of you earning income.

If I offered to pay you 10 cents each year that wouldn’t be all that exciting, but if there were a million copies of you, and I paid each one of them 10 cents a year, now that would be something! ($100,000 per year) “But”, you say, “I don’t have a million dollars to invest”. You could. If you knew and applied a few basic principles, a million dollars would not be difficult to achieve at all.

Did you know that most people in the U.S. will earn more than a million dollars in their working lifetime? If you earned $22,300 each year of your working life, (age 20 – 65), a million dollars will have passed through your hands during that time period. If you set aside $50 each month during that same time period, it is possible to accumulate over a million dollars. 50 dollars a month!

The average American family spends $250 a month on fast food, (not counting their normal grocery bill). Last year I met a nice young couple who were spending $1400 a month eating out and they were not putting anything away for the future.

The truth is, you can save $25, $50, $75 each month. It has been my experience that most people who say they don’t have any extra money to save, basically are not aware of where the money is “leaking” to. Try this, for just one week, write down everything you spend your money on; every last cent. (Be honest). I have found that having a self-awareness of your behaviors is the first step toward personal change.

Once you made it through the week, go for a second, then a third. By the time you begin the second month, you will have made some important discoveries about you and your family’s spending habits that will surprise you. The only thing standing between you and financial abundance, is commitment.

Next Post: A story about llamas

Four ways to earn income

1. Trade time for money

This is the most common way the average person gets income. We sell our personal time to an employer and receive money in return. This method of getting income has several drawbacks.

First: Limited supply of “product” for sale. You only have a certain number of hours each day that can be traded for money, i.e. there is a limit to the number of hours you can work. Also, there will come a time when no one will want to purchase your time from you. And what if you become ill and can’t work? You won’t have any time to sell to an employer and so, the income stops.

You may think, “if I could just get enough money for each hour that I sell, then I would be financially comfortable”. That may be so, (for awhile), but I guarantee that there will come a point when either no one will want to buy your time, or you won’t want to sell it anymore, then the income stops. If you don’t sell your time to someone, you don’t have any income.

Another drawback is, once you have sold your time, if you want to use any of it for yourself, you have to ask permission to get it back. The owner of your time, (your boss), tells you what you can and can’t do with the time he/she bought. For example, if you want to go home early to be with your children, friends, go to the doctor, etc., you have to ask for permission to use some of the time that you sold.

But what if I am self-employed, I am the boss of my own time, right? Yes, but, (and it is a biggie), once you agree to sell your time to a client or customer, they become the owner of your time and you have an obligation to them as to how you use your time. Also, you still have the problems of a limited supply of “product” and situations that prevent you from being able to sell your time, (illness, etc.).

The bottom line is this, most of us have to sell our time for money. That in and of itself isn’t what causes financial discomfort. To have financial abundance, you must also use at least one of the other three methods of earning income, (using all four is the best, of course).

Next post: The 4th way to earn income. (#2 & 3 will come later)