'How Does One Learn to Make Money "work for them"?

Friday, October 10, 2008
John C. DeMoss, CFA

There are of course many ways you can use money to work to make more money, and really it runs the gammit.. from private investment in businesses to investing in commodities, fund managers and the stock market, etc.  However, in your situation, with "only a little", it's important to be thinking in terms of 10, 20 years down the road, or more.  While I do not know your age or anything about your situation, I do know that a little bit at a time, over a long period of time can amount to a substantial amount... in fact it is quite important for many people to think in those terms if they expect to live off of investment income when/if they retire.  For example, lets assume your house is paid for when you retire and that you need something like $40,000/year to sustain the lifestyle that you would like (including any tithing, health care costs, etc).

In the "distribution phase" unless you have substantial net worth and few portfolio restraints due to external circumstances, you need to have income producing investments and a relatively conservative allocation of investments, so you could expect a portfolio that gives you no more than 6% or so, net return.  If inflation is 3%, then you really only earned 3%.  To generate $50,000 in today's dollars, and adjust annually for inflation, you would need a portfolio that is approximately 1 - 1.3 million dollars.  Typically social security is a MAJOR help which could change your portfolio size needs to something along the lines of $500,000 - 750,000 million. Any otjher income that you can generate while in retirement can have a substantial impact on what you need, investment wise.

Now, two glimmers of hope.

1) You are probably in the best time in any life today to begin this process of saving and investing.  With the stock market down to levels unseen in many years, you are beginning your process somewhere near the bottom of an economic cycle.. what this means is that your "rate of return" over the next 25 years is likely to be substantially higher than the "long term average".

2) The numbers add up when your investments compound (ie you start with $1000, then you earn 10% and have $1100 at year end.  You earn another 10%.  Now you earned 10% of $1100, which is $110. That extra $10 is compounding... and it increases exponentially when you start taking it out 25-30 years.  Ill give some examples, since I dont know your propensity to save, but if you were able to manage the following savings rates per year, at an 8.5% annual average return, you would have the respective portfolio sizes in 25 and 30 years, respectively.

$1000/year for 25 years: $79k; for 30 years: 124k

$5,000/year for 25 years: $393k; for 30 years: 621k

$7,500/year for 25 years: $590k; for 30 years: 930k

$10,000/year for 25 years: $786k; for 30 years: $1.25 million

Lastly, if you cant save $10,000/year right now, invest in things like education and your career. Later in life there is time for catch up if you cant do the "perfect scenario" starting today.

 

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