Term insurance is the simplest form of life insurance. Here's how it works.
Term insurance is the simplest form of life insurance. It provides temporary life insurance protection on a limited budget. Here’s how it works:
When policyholders buys term insurance, they buy coverage for a specific period and pay a specific price for that coverage.
If the policyholder dies during that time, their beneficiaries receive the benefit from the policy. If they outlive the term of the policy, it is no longer in effect. The person would have to reapply to receive any future benefit.
Unlike permanent insurance, term insurance only pays a death benefit. That’s one of the reasons term insurance tends to be less expensive than permanent insurance.
Many find term life insurance useful for covering specific financial responsibilities if they were to die unexpectedly. Term life insurance is often used to provide funds to cover:
*College education for dependents
Would term life insurance be the best coverage for you and your family? That depends on your unique goals, needs, and circumstances. You may want to carefully examine the pros and cons of each type of life insurance before deciding what type of policy will be the best fit for you.
Another factor to think about: term policies generally become more expensive as you grow older. If your term life insurance expires and you are facing certain health challenges, such as an injury or disease, you may find that a policy with similar coverage may be much more expensive.
Several factors will affect the cost and availability of life insurance, including age, health, and the type and amount of insurance purchased. Life insurance policies have expenses, including mortality and other charges. You should consider determining whether you are insurable before implementing a strategy involving life insurance. Any guarantees associated with a policy are dependent on the ability of the issuing insurance company to continue making claim payments.
This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note - investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.
1 - nbcnews.com/better/pop-culture/how-much-life-insurance-do-i-need-ncna935811 [11/24/18]
A look at where stocks were in 2009 and how they have performed since.
Where were you on March 9, 2009? Do you remember the headwinds hitting Wall Street then? When the closing bell rang at the New York Stock Exchange that Monday afternoon, it marked the end of another down day for equities. Just hours earlier, the Wall Street Journal had asked: “How Low Can Stocks Go?”1
The Standard & Poor’s 500 stock index answered that question by sinking to 676.53, even with mergers and acquisitions making headlines. The index was under 700 for the first time since 1996. The Dow Jones Industrial Average tumbled to a closing low of 6,547.05.2
To quote Dickens, “It was the best of times, it was the worst of times.” It was the bottom of the bear market – and it was also the best time, in a generation, to buy stocks.2
The next day, a rally began. Buoyed by news of one major bank announcing a return to profitability and another stating it would refrain from further government bailouts, the Dow rose 597 points for the week ending on March 16, 2009. On March 26, the Dow settled at 7,924.56, more than 20% above its March 9 settlement. The bull market was back.3
This bull market would make all kinds of history. In fact, it would become the longest bull market in history – at least by one measure.2
While the last 10-plus years have seen some big ups and downs for the benchmark S&P 500, the index has never closed more than 20% below a recent peak in that span, meaning the current bull market is more than 10 years old.2
Ten years later (at the close on Friday, March 8, 2019), the S&P 500 had risen 305.5% from that low. The Dow had gained 288.7%.2
How about the Nasdaq Composite? 483.94%. (As you look at these impressive numbers, remember that past performance may not be indicative of future results.)4,5
Those gains did not come without turbulence, and stocks in no way turned into a “sure thing.” The risk inherent in the market is still substantial along with the potential for loss. The lesson this long bull market has taught is simply that the bad times in the stock market are worth enduring. Good times may replace those bad times more swiftly than anyone can anticipate.
1 - forbes.com/2010/03/06/march-bear-market-low-personal-finance-march-2009.html [3/6/10]
2 - thestreet.com/investing/stocks/bull-market-10th-anniversary-14891697 [3/10/19]
3 - tinyurl.com/yyhbtfw8 [4/2/19]
4 - bigcharts.marketwatch.com/historical/default.asp?symb=COMP&closeDate=03%2F09%2F2009&x=0&y=0 [4/2/19]
5 - bigcharts.marketwatch.com/historical/default.asp?symb=COMP&closeDate=3%2F08%2F19&x=0&y=0 [4/2/19]
Even the most seasoned investors are prone to their influence.
Investors are routinely warned about allowing their emotions to influence their decisions. They are less routinely cautioned about letting their preconceptions and biases color their financial choices.
In a battle between the facts & our preconceptions, our preconceptions may win. If we acknowledge this tendency, we may be able to avoid some unexamined choices when it comes to personal finance; it may actually “pay” us to recognize our biases as we invest. Here are some common examples of bias creeping into our financial lives.1
Valuing outcomes of investment decisions more than the quality of those decisions. An investor thinks, “I got a great return from that decision,” instead of thinking, “that was a good decision because ______.”
How many investment decisions do we make that have a predictable outcome? Hardly any. In retrospect, it is all too easy to prize the gain from a decision over the wisdom of the decision, and to, therefore, believe that the decisions with the best outcomes were in fact the best decisions (not necessarily true).
Valuing facts we “know” & “see” more than “abstract” facts. Information that seems abstract may seem less valid or valuable than information that relates to personal experience. This is true when we consider different types of investments, the state of the markets, and the health of the economy.
Valuing the latest information most. In the investment world, the latest news is often more valuable than old news, but when the latest news is consistently good (or consistently bad), memories of previous market climate(s) may become too distant. If we are not careful, our minds may subconsciously dismiss the eventual emergence of the next bear (or bull) market.
Being overconfident. The more experienced we are at investing, the more confidence we have about our investment choices. When the market is going up and a clear majority of our investment choices work out well, this reinforces our confidence, sometimes to a point where we may start to feel we can do little wrong, thanks to the state of the market, our investing acumen, or both. This can be dangerous.
The herd mentality. You know how this goes: if everyone is doing something, they must be doing it for sound and logical reasons. The herd mentality is what leads many investors to buy high (and sell low). It can also promote panic selling. Above all, it encourages market timing – and when investors try to time the market, they frequently realize subpar returns.
Sometimes, asking ourselves what our certainty is based on and what it reflects about ourselves can be a helpful and informative step. Examining our preconceptions may help us as we invest.
1 - forbes.com/sites/theyec/2018/12/14/three-psychological-biases-that-prevent-effective-financial-management [12/14/18]
How do these investment approaches differ?
Ever heard the term “strategic investing”? How about “tactical investing”? At a glance, you might assume that both these phrases describe the same investment approach.
While both approaches involve the periodic adjustment of a portfolio and holding portfolio assets in varied investment classes, they differ in one key respect. Strategic investing is fundamentally passive; tactical investing is fundamentally active. An old saying expresses the opinion that strategic investing is about time in the market, while tactical investing is about timing the market. There is some truth to that.1
Strategic investing focuses on an investor’s long-range goals. This philosophy is sometimes characterized as “set it and forget it,” but that is inaccurate. The idea is to maintain the way the invested assets are held over time, so that through the years, they are assigned to investment classes in approximately the percentages established when the portfolio is created.1
Picture a hypothetical investor. Assume that she starts investing and saving for retirement with 60% of her invested assets held in equities and 40% in fixed-income vehicles. Now, assume that soon after she starts investing, a long bull market begins. The value of the equity investments within her portfolio increases. Years pass, and she checks up on the portfolio and learns that much more than 60% of the value of her portfolio is now held in equities. A greater percentage of her portfolio is now subject to the ups and downs of Wall Street.
As she is investing strategically, this is undesirable. Rebalancing is in order. By the tenets of strategic investing, the assets in the portfolio need to be shifted, so that they are held in that 60/40 mix again. If the assets are not rebalanced, her portfolio could expose her to more risk than she wants – and the older she gets, the less risk she may want to assume.1
Tactical investing responds to market conditions. It looks at the present and the near future. A tactical investor attempts to shift the composition of a portfolio to reduce risk exposure or to take advantage of hot sectors or new opportunities. This requires something of an educated guess – two guesses, actually. The challenge is to appropriately decide when to adjust the portfolio in light of change and when to readjust it back to the target investment mix. This is, necessarily, a hands-on style of investing.1
Is it better to buy and hold, or simply, to respond? This question has no easy answer, but it points out the divergence between strategic and tactical investing. A strategic investor may be inclined to “buy and hold” and ride out episodes of Wall Street turbulence. The danger is in holding too long – that is, not recognizing the onset of a prolonged downturn that could bring losses without much hope for a quick recovery. On the other hand, the tactical investor risks buying high and selling low, for figuring out just when to increase or decrease a portfolio position can be difficult.
Investors have debated which strategy is better for decades. One approach may be better suited than another at a particular point in time. Adherents of strategic investing point to the failure of active asset management to beat the equity benchmarks. A 2018 Dow Jones Indices SPIVA Report noted that across the five years ending June 30, 2018, more than 76% of U.S. large-cap funds failed to return better than the S&P 500. A proponent of tactical investing might counter that by arguing that this percentage might be much lower within a shorter timeframe. Ultimately, an investor has to consider their risk tolerance, objectives, and investing outlook in evaluating both approaches.2
This material was prepared by MarketingPro, Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. This information has been derived from sources believed to be accurate. Please note - investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for avoiding any Federal tax penalty. This is neither a solicitation nor recommendation to purchase or sell any investment or insurance product or service, and should not be relied upon as such. All indices are unmanaged and are not illustrative of any particular investment.
1 - money.usnews.com/investing/investing-101/articles/2018-07-25/whats-the-difference-between-strategic-and-tactical-asset-allocation [7/25/18]
2 - us.spindices.com/spiva/#/reports [2/5/19]
Being healthy not only makes you feel good, it may also help you financially.
We constantly hear how important it is to maintain a healthy lifestyle. That is not always easy, especially in the face of temptation or the easy option of procrastination. For some, the monetary benefits of maintaining a healthy lifestyle may provide an incentive.
Being healthy not only makes you feel good, it may also help you financially. For example, a recent Johns Hopkins Bloomberg School of Public Health study determined that a 40-year-old who simply moves from being obese to overweight could save an average of $18,262 in health care costs over the rest of his or her lifetime. If that person maintains a healthy weight, the average potential savings increase to $31,447.1
If you’re wondering how your health habits might be affecting your bottom line, consider the following:
Regular preventative care can help reduce potential health care costs. Even minor illnesses can lead to missed work, missed opportunities, and potentially lost wages. Serious illnesses often involve major costs like hospital stays, medical equipment, and doctor’s fees. Preventative dentistry may help you reduce dental costs as well.
In a way, staying healthy helps our potential to save for retirement. If your health declines to the point where you cannot work, that hurts your income and your ability to contribute to retirement accounts. The threat is real: the Social Security Administration notes that a quarter of us will become disabled at some point during our working years.2
Overweight workers may be subjected to wage discrimination. A LinkedIn study of almost 4,000 full-time and part-time workers found that the workers whose weights were greater than normal earned an average of $2,512 less annually than the others.3
Higher weight seems to be a factor in overall health care costs for many. Ask the Centers for Disease Control and Prevention. The CDC notes that per-year health care expenses are about 41% higher ($4,870) for an obese individual than for a person of normal weight ($3,400). The biggest factor in this difference: prescription drug costs.4
Some habits that lead to poor health can be expensive in themselves. Smoking is the classic example. A pack of cigarettes costs anywhere from $5-14, which means ballpark expenses of $2,000-5,000 or more a year in expenses for a pack-a-day smoker. Smokers also pay higher premiums for health, disability, and life insurance.5
By focusing on your health, eliminating harmful habits, and employing preventative care, you may be able to improve your self-confidence and quality of life. You may also be able to reduce expenses, enjoy more of your money, and boost your overall financial health.
1 - https://www.bankrate.com/banking/savings/healthier-lifestyle-can-save-you-money/ [9/25/18] 2 - https://www.cnbc.com/2018/11/11/protect-yourself-from-a-career-derailment-that-trips-up-1-in-4-workers.html [11/11/18]
3 - https://www.foxbusiness.com/features/employers-pay-overweight-workers-less-new-study-reveals [11/5/18] 4 - https://abcnews.go.com/Health/Healthday/story?id=8184975&page=1 [7/28/18] 5 - https://money.usnews.com/money/personal-finance/family-finance/articles/the-real-cost-of-smoking [11/20/18]
What all new and prospective homeowners need to know.
If you arrange a mortgage, your lender will want you to have homeowners insurance. This coverage is critical for protecting your home and personal property against various potential liabilities.
A homeowners insurance policy is actually a package of coverages. These policies commonly offer the following forms of protection:
*Dwelling coverage insures your house and any attached structures, including fixtures such as plumbing and electrical and HVAC systems, against damages.1
*Other Structures coverage is included to compensate you for damage to structures unattached to the main dwelling on your property, such as a detached garage, tool shed, or fence.1
*Personal Property coverage addresses damage to your personal possessions, such as your appliances, furniture, electronics, and clothes.1
*Loss of Use coverage reimburses you for additional living expenses if you are unable to live in your home due to damages suffered.1
*Personal Liability coverage is designed to pay out claims if you are found liable for injuries or damages to another party. As an example, say someone attends a barbeque held in your backyard, then stumbles over a tree root and breaks a wrist or an ankle.1
*Medical Payments coverage pays the medical bills incurred by people who are hurt on your property, or hurt by your pets. This is no-fault coverage. If someone is hurt at your house, any resulting medical bills may be sent by that person to your insurer.1
These coverages pertain only to losses caused by a peril covered by your policy. For instance, if your policy doesn’t cover earthquake damage, then losses will not be reimbursed.1
The types of covered perils will depend on the type of policy you buy. Special Form policies are the most popular, since they insure against all perils, except those specifically named in the policy. Common exclusions include earthquakes and floods. Typically, flood insurance is obtained through the National Flood Insurance Program, while earthquake coverage may be obtained through an endorsement or a separate policy. Some homeowners are reluctant to buy flood or earthquake coverage; they think it is too expensive and may never be needed. The thing is, the future cannot always be guessed by looking at the past.2
Your policy will of course limit the amount of covered losses. If you have a valuable art collection or jewelry, you may want to secure additional insurance on those items.
When you scrutinize a policy, see if it insures your residence for replacement cost or actual cash value. Actual cash value is less preferable: it may not cover all your losses, as the value of your personal property can be affected by wear and tear, and your home’s value can be affected by housing market fluctuations. If your home is insured for replacement cost, then the insurance carrier will pay the expenses of using materials of similar kind and quality to rebuild or repair your home.3
As a last note, you may also want Umbrella Liability coverage. Do you consider yourself wealthy? You may find the liability limits on your current homeowners policy inadequate. For a greater degree of coverage, you might elect to complement it with an umbrella policy.4
1 - https://www.iii.org/article/what-covered-standard-homeowners-policy [12/3/18]
2 - https://www.valuepenguin.com/types-homeowners-insurance [9/25/18] 3 - https://www.thebalance.com/replacement-cost-insurance-vs-actual-cash-value-4154015 [11/18/18] 4 - https://www.kiplinger.com/article/insurance/T028-C000-S002-why-you-need-an-umbrella-insurance-policy.html [9/25/18]
That truth must always be recognized.
When financial markets have a bad day, week, or month, discomforting headlines and data can swiftly communicate a message to retirees and retirement savers alike: equity investments are risky things, and Wall Street is a risky place.
All true. If you want to accumulate significant retirement savings or try and grow your wealth through the opportunities in the markets, this is a reality you cannot avoid.
Regularly, your investments contend with assorted market risks. They never go away. At times, they may seem dangerous to your net worth or your retirement savings, so much so that you think about getting out of equities entirely.
If you are having such thoughts, think about this: in the big picture, the real danger to your retirement could be being too risk averse.
Is it possible to hold too much in cash? Yes. Some pre-retirees do. (Even some retirees, in fact.) They have six-figure savings accounts, built up since the Great Recession and the last bear market. It is a prudent move. A dollar will always be worth a dollar in America, and that money is out of the market and backed by deposit insurance.
This is all well and good, but the problem is what that money is earning. Even with interest rates rising, many high-balance savings accounts are currently yielding less than 0.5% a year. The latest inflation data shows consumer prices advancing 2.3% a year. That money in the bank is not outrunning inflation, not even close. It will lose purchasing power over time.1,2
Consider some of the recent yearly advances of the S&P 500. In 2016, it gained 9.54%; in 2017, it gained 19.42%. Those were the price returns; the 2016 and 2017 total returns (with dividends reinvested) were a respective 11.96% and 21.83%.3,4
Yes, the broad benchmark for U.S. equities has bad years as well. Historically, it has had about one negative year for every three positive years. Looking through relatively recent historical windows, the positives have mostly outweighed the negatives for investors. From 1973-2016, for example, the S&P gained an average of 11.69% per year. (The last 3-year losing streak the S&P had was in 2000-02.)5
Your portfolio may not return as well as the S&P does in a given year, but when equities rally, your household may see its invested assets grow noticeably. When you bring in equity investment account factors like compounding and tax deferral, the growth of those invested assets over decades may dwarf the growth that could result from mere checking or savings account interest.
At some point, putting too little into investments and too much in the bank may become a risk – a risk to your retirement savings potential. At today’s interest rates, the money you are saving may end up growing faster if it is invested in some vehicle offering potentially greater reward and comparatively greater degrees of risk to tolerate.
Having a big emergency fund is good. You can dip into that liquid pool of cash to address sudden financial issues that pose risks to your financial equilibrium in the present.
Having a big retirement fund is even better. When you have one of those, you may confidently address the biggest financial risk you will ever face: the risk of outliving your money in the future.
1 - valuepenguin.com/average-savings-account-interest-rates [10/4/18]
2 - investing.com/economic-calendar/ [10/11/18]
3 - money.cnn.com/data/markets/sandp/ [10/11/18]
4 - ycharts.com/indicators/sandp_500_total_return_annual [10/11/18]
5 - thebalance.com/stock-market-returns-by-year-2388543 [6/23/18]
There is really no reason to wait.
October is here – the ideal time for college students to apply for financial aid. October 1, in fact, marks the first day a current or future college student can submit a Free Application for Federal Student Aid, or FAFSA, for the 2019-20 academic year. Since some states offer aid on a first-come, first-serve basis, submitting a FAFSA as soon as possible is wise.1,2
You can even apply using your phone. Install the new myStudentAid app created by the Department of Education, available for iOS and Android operating systems. While filling out the FAFSA takes time whether you use a PC, tablet, phone, or pen, it may feel easier to start on a phone. In fact, Mark Kantrowitz, publisher of SavingForCollege.com, just remarked to CNBC that the mobile app was “much easier to use, even fun.” The FAFSA asks students and parents more than 100 questions, so any degree of “fun” is good. (Thanks to the new app, you can start filling out a FAFSA on a computer and finish it on a phone, and vice versa.)1,2
Due to the new phone app, more FAFSAs might be filed this year. Slightly more than 20 million FAFSAs were submitted for the 2014-15 award cycle; in contrast, just over 10 million were filed for 2018-19. This decline might reflect an improved economy and a boost in household wealth, but it may be temporary.2
What should your student have handy while filling out the form? After creating an FSA ID (a username, a password), your student will need to reference all kinds of personal information, some of which will be yours. The FAFSA asks for birth dates, Social Security numbers, and driver’s license numbers. It asks for financial information: savings account balances, home values, investment account values. (It does not require you to report balances of workplace retirement plan accounts, pension plans, or IRAs.) Untaxed income must be figured; interest income and child support fall into that category.1
All FAFSAs now require federal tax information from the year that is two years prior to the current award cycle. In other words, on this year’s FAFSA, you need to include federal tax information from 2017. This may not be as arduous as it sounds because you can use the Internal Revenue Service Data Retrieval Tool (irsdataretrievaltool.com). This online tool lets you import your 2017 federal tax information straight into the FAFSA; it is accessed through a “Link to I.R.S.” button. (Information input into the Data Retrieval Tool must match what appeared in the federal tax return.)2,3
A FAFSA must list at least one college or university that the student currently attends or wants to attend. When multiple schools are listed, grant awards are made to the school listed first. (Colleges and universities can also be removed from a list of multiple schools.)1
Anyone who provides data for a FAFSA (a student, a parent, a college access advisor) must also sign that FAFSA. Without the appropriate signatures, the application is invalid. When it comes to these signatures, here is a tip all parents should remember: never hit the “Start Over” button when you log in to add your signature. If you accidentally click on that, all the information that your student has spent hours entering will be erased.1,2
Financial questions should not be left blank on the FAFSA. If the answer to a question is “none,” put a zero instead of nothing at all. Every monetary amount that includes cents should be rounded to the nearest dollar.1
Unsurprisingly, some families want help when filling out the FAFSA. Recognizing this, the Department of Education offers a 66-page guide to completing the form; you will find it at studentaid.ed.gov. It also provides a FAFSA hotline: (800) 433-3243. You may want to chat with a financial professional who focuses on college planning or a university financial aid officer for additional insight.1
The FAFSA is often a pathway to considerable financial assistance: grants, work study programs, federal student loans. The average FAFSA applicant for the 2015-16 school year received roughly $8,500. A FAFSA costs nothing to fill out or send around, and there is absolutely nothing to lose in submitting one.2
1 - tinyurl.com/yd7l9u9z [9/12/18]
2 - cnbc.com/2018/09/18/you-can-now-apply-for-financial-aid-on-your-phone.html [9/18/18]
3 - studentaid.ed.gov/sa/resources/irs-drt-text [9/27/18]
Riding all of the stock market’s ups – and none of its downs – is a popular fantasy. Who wouldn’t want to skip rough patches such as early 2018, late 2015 or all of 2008?
Alas, it’s impossible. Even the greatest investors are wrong maybe a third of the time.
But here’s some good news: You don’t need perfect timing to achieve marvelous returns. Time in the market beats timing the market – almost always.
Why? Consider three make-believe siblings, each with $10,000 to invest in U.S. stocks each year from 1977 to 2018 – a stretch that includes five bear markets.
Pretend they bought the Standard & Poor's 500 stock index (broader than the Dow).
Janette, with perfect timing, invests at each year’s monthly market low, earning each year’s full upside. Jebediah, a terrible timer, invests at each year’s monthly market high, missing more gains and capturing more downside. Jackpot, the clever youngest brother, knows he has no timing ability. He invests the first day of each year.
Fast-forward to June 2018. Janette’s 41 years of perfect timing earned an average annual return of 11.4 percent for a cool $8.2 million. No-timing Jackpot was close behind, with an 11.1 percent return and $7.8 million – still great. Even terrible-timing Jebediah got a 10.8 percent return – turning his $410,000 in contributions into $6.7 million. Sure, it's rewarding enough, but lagging little brother, no-timing Jackpot by $1.1 million is a high price to pay for bad timing.
Being Janette is impossible. Even trying to be Janette runs the risk of becoming Jebediah – or worse. Fancy timing increases the likelihood of errors.People want to buy after stocks rise, not after they drop. Were you eagerly buying this March, when the early-year correction avalanched? Or in February 2016 as headlines hyped election risks at the bottom of an eight-month slide? Or in March 2009 at the depths of the financial crisis? As I said last week, the best time to buy is surely when people least want to.
But time overwhelmingly swamps timing, good or bad. How so?
Consider Jill and Joaquin. Jill invests $10,000 in U.S. stocks each year, starting in 1977. Like Jebediah, Jill has terrible timing, buying at each year’s monthly market high. Then, Jill stops contributing after 10 years, stops trading and just lets her S&P 500 stocks ride. Meanwhile, procrastinating Joaquin waits till 1987 to start investing his $10,000 annually. Yet Joaquin has perfect timing and, unlike Jill, keeps adding $10,000 every year through 2018. Surely this deck must be stacked against Jill.
No. Even with poor timing, Jill turned her $100,000 in contributions to $216,576 in stocks by the time Joaquin invests his first $10,000. Her head start more than offsets Joaquin’s perfect timing and greater total contributions. In June 2018, she has just over $5 million. Joaquin has less than half that, around $2.1 million. Jill’s compound time-in-the-market growth trounced Joaquin’s perfect timing.
Think you’d never be Joaquin? As I wrote last month, many investors left stocks after the financial crisis and stayed away for years. Many still haven’t returned. Yet since the March 9, 2009, low, U.S. stocks are up 419 percent with dividends. Since the precrisis peak? Up 132 percent. You didn’t need marvelous timing to come out ahead.
Remember these examples the next time markets sag and you want to bail – or the next time you have cash you’re waiting to invest. Is your desire to avoid bad times worth the risk of being Jebediah or Joaquin?
Author: Keneth Fisher
Save and invest, year after year, to put the full power of compounding on your side.
Have you been saving for retirement for a decade or more? In the foreseeable future, something terrific is likely to happen with your IRA or your workplace retirement plan account. At some point, its yearly earnings should begin to exceed your yearly contributions.
Just when could this happen? The timing depends on several factors, and the biggest factor may simply be consistency – your ability to keep steadily investing and saving. The potential for this phenomenon is apparent for savers who start early and savers who start late. Here are two mock scenarios.
Christina starts saving for retirement at age 23. After college, she takes a job paying $45,000 a year. Each month, she directs 10% of her salary ($375) into a workplace retirement plan account. The investments in that account earn 6% per year. Thirteen years later, Christina is still happily working at the same firm and still regularly putting 10% of her pay into the retirement plan each month. She now earns $58,200 a year, so her monthly 10% contribution has risen over the years from $375 to $485.1
The ratio of account contributions to account earnings has tilted during this time. After eight years of saving and investing, the ratio is about 2:1 – for every two dollars going into the account, a dollar is being earned by its investments. During year 13, the ratio hits 1:1 – the account starts to return more than $500 per month, with a big assist from compound interest. In years thereafter, the 6% return the investments realize each year tops her year’s worth of contributions to the principal. (Her monthly contributions have grown by more than 20% during these 13 years, and that also has had an influence.)1
Fast forward to 35 years later. Christina is now 58 and nearing retirement age, and she earns $86,400 annually, meaning her 10% monthly salary deferral has nearly doubled over the years from the initial $375 to $720. This has helped her build savings, but not as much as the compounding on her side. At 58, her account earns about $2,900 per month at a 6% rate of return – more than four times her monthly account contribution.1
Lori needs to start saving for retirement at age 49. Pragmatic, she begins putting $1,000 a month into a workplace retirement plan. Her account returns 7% a year. (For this example, we will assume Lori maintains her sizable monthly contribution rate for the duration of the account.) By age 54, thanks to compound interest, she has $73,839 in her account. After a decade of contributing $12,000 per year, she has $177,403. She manages to work until age 69, and after 20 years, the account holds $526,382.2
These examples omit some possible negatives – and some possible positives. They do not factor in a prolonged absence from the workforce or bad years for the market. Then again, the 6% and 7% consistent returns used above also disregard the chance of the market having great years.
Repeatedly, investors are cautioned that past performance is no guarantee or indicator of future success. This is true. It is also true that the yearly total return of the S&P 500 (that is, dividends included) averaged 10.2% from 1917-2017. Just stop and consider that 10.2% average total return in view of all the market cycles Wall Street went through in those 100 years.2
Keep in mind, when the yearly earnings of your IRA or employer-sponsored retirement plan account do start to exceed your yearly contributions, that is not a time to scale back your contributions. Your retirement account will not do all your retirement saving work for you at that point; you still need to keep the momentum of your saving effort going – and maintaining it will assist the compounding.
1 - time.com/money/5204859/retirement-investments-savings-compounding/ [3/21/18]
2 - fool.com/investing/2018/05/16/how-to-invest-1000-a-month.aspx [5/16/18]