Wednesday, July 21, 2010

Investing for the Long Term

The Power of Postponement

Although recent experience has been discouraging, compounding investment returns over many years yields truly amazing numbers. Consider how money grows in an IRA for a young person who leaves the money alone until retirement.

The maximum contribution to an IRA is $5,000 a year for someone under age 50 (the money must come from earned income although parents can replace the contribution). Take a 20-year-old who earned and saved enough to put $5,000 in an IRA. Let's invest that money in a broad index that gets 10 percent returns, the average of stocks over the last century. After 50 years, the account would be worth $587,000 (this doesn't factor in inflation).

If he waits ten years, until age 30, the total at retirement would be less than half, $226,000. At 40, it would be $87,000; at 50, $34,000 and at 60, the total grows to $13,000.

These are average figures and the results could differ significantly. But this shows three things: how long you invest - whether for yourself, your children or grandchildren - is critical; the benefits of tax deferral make a huge difference; and achieving the broad stock market returns has been a great goal.