The Overlooked Wealth Building Trait

By in Investing, Retirement | 10 comments

Women’s Money Week Feature Article-How to Take Control of Your Financial Future

Get ready for Barbara Friedberg’s upcoming book,

How to Get Rich; Wealth Building Guide for the Financially Illiterate,” sign up above & be the 1st to know

My Favorite Wealth Building Example

Take this quick quiz to help you understand how your money grows as you reinvest the earnings:

THE POWER OF COMPOUNDING QUIZ

Choose either Option 1 or Option 2

Option 1: Receive a lump sum payment of $100,000 cash at the end of one month.

Option 2: Receive the total value of one penny doubling on the first day of the month and the resultant amount doubling every subsequent day until the end of the month. For example, on day one you get one penny, on day two you get two pennies, on day three your wealth grows to four pennies and on day five your money doubles to eight pennies and so on until the end of the month.

SCORING:

Option 1: Choose this option and on day 31 you have $100,000

Option 2: Choose this option and on day 31 you have $10,737,418.24

Value of a penny doubling each day during a month

Value of a penny doubling each day during a month

Would you believe that one penny doubling every day for a month could be worth over ten million dollars at the end of the month? It’s unfathomable. Of course, getting one hundred percent return every day for a month is impossible, but this example demonstrates how reinvesting ones earnings over long periods of time can build great wealth.

Let’s get a bit more realistic. Invest $5,000 per year in a workplace retirement account and reinvest the earnings. Populate the account with stock and bond mutual funds which earn an annualized return of 7.5%. Start at age 25 and stop at age 65.

How much do you think your $200,000 ($5,000 per year for 40 years) is worth?

At age 65, your 40 year annual contributions of $5,000 per year is worth $1,136,282. Yet in the interim, you may feel like your money is not growing at all. Some years growth will be better than others. After 20 years, your contributions will only be worth $216,523. After 30 years, your $5,000 per year investment is worth $516,997. Add another 10 years and you are a millionaire.

Patience is Crucial in Investing

It’s difficult to imagine that over time, relatively small amounts of money can reap great benefits. Starting out, it may be difficult to find $5,000 per year to invest. But as your income grows, if you keep spending at bay, it’s easier to make that annual investment.

Many folks want it all now, and don’t understand that patience and compounding of returns is an important component in building wealth and getting rich.

How to Take Control of Your Financial Future

1. Begin saving and investing now.

2. Continue through thick and thin.

3. Do not let anything stop you from contributing and investing funds for your future.

Barb Recommends Articles from Women’s Money Week

Barb Across the Web

How patient are you? Does your saving and spending change with your moods?

    10 Comments

  1. Good reminder! I haven’t heard that example in a very long time. I think the surprise is how small the accumulation is after 10 and 20 years , but at 30 it is meaningful. Being a lifelong saver, I may have difficulty spending it in retirement.

    krantcents

    March 8, 2013

  2. Compound interest is a remarkable thing. I showed my 14 year old that with 10% growth, investments double in about 7 years. So over 50 years, nearly 7 ‘doubles’ is 128 fold. The $2000 she deposited into her Roth IRA last year may very well grow to $250,000 in 50 years. (The David claims 12% is what you should plug into the equation. 12% at 50 years equals a 290 fold return over that same time, crazier, still)

    JoeTaxpayer

    March 9, 2013

  3. @Krantc, I get it. One builds these habits, and it’s difficult to extricate yourself from them.

    @Joe, Great job getting your daughter to contribute her earnings into an IRA!! Compound returns is the one thing keeping me happy with getting older LOL :)

    Barb

    March 10, 2013

  4. This is awesome! It shows that starting early is more important than starting big. So often people procrastinate with investing because they think what they have is too small…

    William @ Bite the Bullet

    March 12, 2013

  5. Hi William, I am fascinated by the power of compounding and have seen it work in our own lives as well. Thanks for chiming in.

    Barb

    March 12, 2013

  6. Such an awesome example! I use games like this to get my finance students to understand how important compounding is. You put together such a great round up too!

    Nunzio Bruno

    March 13, 2013

    • Nunzio, I’ve had students who absolutely cannot believe the example. It is astounding after all :)

      Barb

      March 14, 2013

  7. Your example also illustrates how counterintuitive exponential math is to the human brain. We have an intuitive grasp of arithmetic, so we can easily understand how much our take home pay increases per week if we receive a 5% annual raise. On the other hand, we have no idea how much 7% compounded over 30 years would be or how much our monthly mortgage payment would be reduced if the interest rate was 2% less.

    The main thing to understand is that these results aren’t obvious to us. Don’t try to guess. Instead, learn how to use available tools and calculators.

    S. B.

    March 18, 2013

  8. @SB, So true, it is certainly not intuitive that funds overtime can compound so dramatically. And on the reverse, that is why debt is so detrimental, and the interest payments due on debt compound if one doesn’t pay off their debt expeditiously.

    Barb

    March 19, 2013

Post a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>

WP-SpamFree by Pole Position Marketing