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How Much Did That Really Cost?

10/27/00 02:54:38 PM PST
by Bruce R. Faber

Figure 1 tells the whole story; this is just the translation. The biggest challenge is making sure your kids read it too. And your nieces and nephews, and the kids next door. This is the kind of life-changing and habit-altering information that has always been out there, but for some reason never reaches those who need it most. And here it is, in the plainest of English and as clear as it has ever been presented. Preaching to the choir isn't much help, because you probably already know this. This will help you explain it in no uncertain terms to those who don't.

You want details? Here they are
"The rich get richer and the poor get poorer." You've heard that old saying, and it's sad because it's often so very true. The reason it's true is because the rich know -- and take advantage of -- their working money.

Let's take a pair of basketball shoes as a prime example. There is a pair with the name of a certain airborne superstar that goes for about $130. Or, there is a very good pair, without the big name, that can be purchased for about $60. Say you're 15 years old and making $5.15 an hour flipping burgers after school. After taxes, you get home with about 75% of what you make, or about $3.90 an hour. So you're flipping burgers for a while, and you can finally afford those brand-name shoes! But hey, it's worth the extra money to get the "name" ones.

Or is it? How much did those shoes really cost? Let's figure it out.

Say you decided to buy the $60 pair instead and put the other $70 in an Ira. If that Ira only gets a 10% interest rate, and you never ever put another dime into the account, and you let that $70 compound until the current retirement age of 65, your decision of forgoing that big name on your new pair of sneakers could put a nice amount into the account --$7,472!

Huh, you think. A lightbulb gets switched on. Maybe you -- or your kids -- should reconsider your discretionary buying decisions while you're younger if you want to be rich when you retire.

It gets even better: If you are 50, every $1 in your Ira at age 65 will be worth $4.18.
If you are 40, it will be worth $10.83.
If you are 30, it will be worth $28.10.
If you are 20, it will be worth $72.89.
If you are 16, it will be worth $106.72.

  • Based on these numbers, on the day you turn 50, that large Pizza Supreme you just ordered to eat while you watch the game doesn't cost the $21 you forked over to the kid who delivered it; it really cost more than $85.

  • On the day you hit the big 4-0, for those of you who would be so inclined, you might go out and splurge on a new purse. It cost $55. You thought you got a bargain on that purse. Did you? Using the numbers you see for age 40, it really cost you almost $600!

  • Say you bought a set of four mag wheels for your car when you just turned 30. You thought you got a steal when you bought them for just $200. What did it really cost you? It cost you $5,620!

  • Say you just turned 20. Money is hard to come by, and school costs a ton. You are so busy that you only take time to stop by the fast-food place every day for lunch. You get a burger, fries, and a soda for about $4 instead of fixing yourself a lunch from something you bought at the grocery store for about $2. But that's only five days a week because someone takes pity on you on the weekends and invites you out for lunch. Heck, you say to yourself in the flush of youth, it's only a couple of bucks' difference. You think so? Well, chew on this. Those same two bucks a day invested in your Ira for just three months just cost you a nice cruise in your retirement. The total taken out of your golden years is, just by opting for the fast food in lieu of the sandwich from home -- are you ready? -- $9,475. Are you sure you want fries with that?

  • The art of compounding
    Money works through something called compounding. Take a look at the sidebar, "The power of compounding," for a simple formula to demonstrate how this happens. Although the 10% annual return used here is very conservative by today's growth numbers, you can see how your dollars grow.

    How does it work? Money works, but it works slow! Start saving early and let it grow! (Pardon the rhyme.)

    Here's another nice thing about getting started early. It not only gives you a lot of money when you retire, you can spend a whole lot more money during your working life and still have a great retirement, if you saved when you were young versus saving when you are just a little bit older.

    This is the most amazing part about putting your money to work as soon as you can. If you put $2,000 into an Ira on your birthday for 11 years, starting when you turn 16, then you would have more than two and a half times as much money at age 65 than the person who starts putting in $2,000 per year on his or her 30th birthday and continues putting it in every year until age 65. If you want to have some real gold in your golden years, then invest in yourself early on. By the way, if you start investing $2,000 per year at age 16 and keep doing so until you are 65, you will be able to withdraw almost a quarter million dollars a year when you retire as long as you live and still leave more than $2 million to whoever or whatever is important to you.

    So next time, and every time, you have a choice of what to do with your hard-earned cash, make sure that you first save enough to fund your Ira with the $2,000 maximum amount. Ask yourself, "How much does that really cost?"


    The power of compounding
    When money is put to work, the wage that it earns is referred to as interest. This interest compounds -- that is, after the first year you are getting interest on the interest itself as well as on the principal. That's the power of your money working for you.

    However, at the beginning it starts working slowly. With a return of 10% per year, it takes more than seven years for your money to double. After that, it starts to pick up speed. After four more years, the compounding increases your original $1 investment to more than $3.

    When you look at the numbers in sidebar Figure 1, keep in mind that every year you delay putting money in your Ira removes the number at the age-65 end of the column of numbers, not from the age-16 beginning. So deciding not to deposit a single dollar at age 16 eliminates the $106.72 figure at the end. These numbers represent every dollar put in an Ira on your 16th birthday. Starting a single year later knocks off $9.70 compounded per dollar saved at the beginning. For the $2,000 maximum you can put into your Ira, that comes to a $19,400 loss!

    The amount of interest earned is usually dependent on the amount of risk to which the money is subjected. If there is very little risk, then there is usually very little interest. If there is a lot of risk -- a great chance that the money invested will be lost -- then the amount of interest is considerable. Government-insured deposits have almost no risk and hence not much earning ability. Speculating on oil wells or Internet startup companies is very risky; most wells are dry, and most Internet startups will fail (certainly statistically). However, when an oil well hits a jackpot of oil or one of the 'Net startups is a hit, the profits and hence the interest returned on the invested money can be very high.

    For the last 60 years or so, the stock market as a whole as well as the major indices (Dow Jones Industrial Average, Standard & Poor's 500, and so forth) have averaged more than 10%. For the last 10 years, the average equity growth has been nearly twice that. The percentage gain used in this example is a very conservative 10%. If you think these numbers are awesome, just think of what they would look like at 20%. Just to give you an idea, just $1 invested in an Ira on your 16th birthday -- with a 20% average return -- is worth more than $7,500 the day you turn 65. That is what compounding does. It starts out slowly, but time gives it phenomenal working power.

    It's up to you. Spend your money now like a drunken sailor, and then work to just get by for the rest of your life, or force yourself to save a little now and live your golden years in comfort by letting your money do the working. --B.F.

    Age 16 2.14 5.05 11.92 28.10 66.26
    $1.00 2.36 5.56 13.11 30.91 72.89
    1.10 2.59 6.12 14.42 34.00 80.18
    1.21 2.85 6.73 15.86 37.40 88.20
    1.33 3.14 7.40 17.45 41.14 97.02
    1.46 3.45 8.14 19.19 45.26 106.72
    1.61 3.80 8.95 21.11 49.79 Age 65
    1.77 4.18 9.85 23.23 54.76
    1.95 4.59 10.83 25.55 60.24

    Sidebar Figure 1: These numbers show how money compounds with time. The emphasis here is on the staggering differences in value each year that savings are delayed. Each dollar deposited at age 16 is worth $9.70 more than a dollar deposited a single year later at age 17. Each dollar is worth $33.83 more than a dollar deposited at age 20, and a whopping $78.62 more, almost four times as much, than dollars deposited at age 30. Money works, but it works slowly.

    Bruce R. Faber

    Title: Staff Writer
    Company: Technical Analysis, Inc.
    Address: 4757 California Ave. SW
    Seattle, WA 98116
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