Theory of
Compounding

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Million
Dollar Habits

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Dare to be
Average

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Frequently Used
Financial Terms

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The Amazing Power of Compounding

Most financially successful people get that way not through business innovation but through compound interest on their savings and investments.

An important lesson they learn early is that a saver can contribute less now than more later to enjoy the same ultimate accumulation of wealth. A simple example: if a 22-year-old invests $1,000 on January 1 at 7% per annum, next year the investor will have $1,070. The following year, the investor will theoretically gain the same 7% on the initial $1,000 plus the $70 earned last year, which would increase the investor’s balance to $1,145. In 10 years, the investor’s initial $1,000 would grow to $1,967.

Upon retirement, at age 65, that single initial investment of $1,000 will have grown to $18,344. Alternatively, to achieve the same nest egg of $18,344 at age 65, a single initial investment at age 32 would need to be $1,967. The magic came from reinvesting the principle plus earned interest every year.
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Million Dollar Habits Explained

By eliminating what I call Million Dollar Habits, (i.e.,exercising spending discipline), almost all of us will rediscover a few dollars we didn’t know we had – enough dollars, at least, to initiate a meaningful savings program in advance of when most people start saving. In short, Million Dollar Habits are behavior patterns that, if not modified or completely corrected, could wind up costing an individual hundreds of thousands if not millions of dollars over a lifetime. The most commonly abused such habit is Impulse Buying.

By eliminating some, or all, of these habits, we save a few bucks a month to invest somewhere that, hopefully, over time will grow into a meaningful retirement fund. And the process does not have to be complicated. In fact, it can be quite simple…the simpler the better. The Million Dollar Question is – do you have the discipline? All it involves is spending less (saving) by simply delaying gratification – and avoiding those Million-Dollar Habits.
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How to Dare to be Average

Next to saving, one of the hardest thing to accomplish as an investor is daring to be average. It’s an index fund’s essence…its overriding fundamental.

Think about it, if you invest in a Total Stock Market Index fund, or less broadly, an S&P 500 Index fund, you’ve deliberately chosen to be satisfied with  a broad market yield. “Why,” you ask, “would I want to just be average?” Truth be told, you’re not just being average. Study after study of index fund (passive) results show that over time, they outperform managed (active) funds. And those managed funds that outperform index funds represent a moving target from one year to the next. In short, here today, probably gone tomorrow.    

Beating the market is hard to do. Accounting for what’s known as “survivorship bias” (the attrition rate of poor performing mutual funds), over a very recent 15-year period, roughly 92% of large-cap funds lagged the yield of a simple S&P 500 index fund. Mid-cap and small-cap funds lagged their benchmark indexes even more: roughly 95% and 93%, respectively. In short, the odds that you’ll do better in an actively managed domestic fund (versus an index fund) are about 1 in 20.

That’s why I dared to be average years ago! Certain “friends” told me that, in my case, being average probably came naturally.
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Frequently Used Financial Terms

The Amazing Power of Compounding – Most financially successful people get that way not through business innovation but through compound interest on their savings and investments. An important lesson they learn early is that a saver can contribute less now than more later to enjoy the same ultimate accumulation of wealth. A simple example: If a 22-year-old invests $1,000 on January 1 at 7% per annum, next year the investor will have $1,070. The following year, the investor will theoretically gain the same 7% on the initial $1,000 plus the $70 earned last year, which would increase the investor’s balance to $1,145. In 10 years, the investor’s initial $1,000 would grow to $1,967. Upon retirement, at age 65, that single initial investment of $1,000 will have grown to $18,344. Alternatively, to achieve the same nest egg of $18,344 at age 65, a single initial investment at age 32 would need to be $1,967. The magic came from reinvesting the principle plus earned interest every year.

Dare to be Average –
Next to saving, one of the hardest thing to accomplish as an investor is daring to be average. It’s an index fund’s essence…its overriding fundamental. Think about it, if you invest in a Total Stock Market Index fund, or less broadly, an S&P 500 Index fund, you’ve deliberately chosen to be satisfied with a broad market yield. “Why?" you ask, “would I want to just be average?” Truth be told, you’re not just being average. Study after study of index fund (passive) results show that over time, they outperform managed (active) funds. And those managed funds that outperform index funds represent a moving target from one year to the next. In short, here today, probably gone tomorrow. Beating the market is hard to do. Accounting for what’s known as “survivorship bias” (the attrition rate of poor performing mutual funds) over a very recent 15-year period, roughly 92% of large-cap funds lagged the yield of a simple S&P 500 index fund. Mid-cap and small-cap funds lagged their benchmark indexes even more - roughly 95% and 93%, respectively. In short, the odds that you’ll do better in an actively managed domestic fund (versus an index fund) are about 1 in 20. That’s why I dared to be average years ago! Certain “friends” told me that, in my case, being average probably came naturally.

Dollar Cost Averaging – An investment technique that involves buying a fixed dollar amount of shares of stock or units of a mutual fund on a regular schedule (say, the 15th of every month), regardless of the share price on that date. In short, the investor purchases fewer units or shares when prices are high and more units or shares when prices are low. A side benefit is that it just might reduce the inclination of an investor to make purchases in a frothy market or sales in a bearish market.

Million-Dollar Habits – Behavior patterns that, if not modified or completely corrected, could wind up costing an individual hundreds of thousands, if not millions, of dollars over a lifetime. The most commonly abused such habit is Impulse Buying (more about impulse buying later).

Rule of 72– The one-step formula used to estimate the number of years required to double invested funds at a given annual rate of return (i.e., if an investment promises an 8% annual compounded rate of return, it will take about 9 years to double the invested money (72/8 = 9). The Rule of 72 applies to cases of compound interest, not to cases of simple interest. Alternatively, if you divide the number of years (within which you want to double your money) into 72, the result is the approximate yield you’ll need to earn to achieve your objective (72/9 = 8%).

The Safe Retirement Withdrawal Rate – A calculation of how much an individual can “safely” pull from a retirement portfolios on an annual basis without significant risk of long-term depletion.

Saving: It’s Never Too Late, But Early Is Best –
This simple maxim is attributable to those wise parents and financial planners among us. In any event, because Time is Money, it’s always wise to start saving as soon as possible…not when you’re hired part- or full-time right out of high school or college, but RIGHT NOW!

Simple Interest – Used for calculating interest on investments where the accumulated interest is not added back to the principle (i.e., multiply the principle amount by the daily interest rate and by the days that elapse between payments).

Time is Money – This simple maxim is often attributed to the wise and witty Benjamin Franklin. He reinforced its meaning by simply stating that if a person skips half-a-day of work, he forfeits half-a-day of wages. Let’s apply this maxim to a delinquent saver using The Amazing Power of Compounding. Had our saver waited until age 40 (instead of age 22) to start saving, to reach the same goal of $18,344 at age 65, he would have to make an initial contribution of $3,380 instead of $1,000. In short, if you don’t start saving until later in life, your required initial contribution will necessarily be larger to reach the same goal at age 65.

The Time Value of Money – This simple concept recognizes that cash in hand is worth more than the same amount of cash received a year from now. Why? Because cash in hand can be invested to earn income during that year.

Uncle Grabby – The U. S. Treasury Department’s Internal Revenue Service and its impulse buying sidekick, the U. S. Congress.

Watch the Pennies and the Dollars Will Take Care of Themselves – Another maxim often incorrectly attributed to Benjamin Franklin (and frequently used by my father), but first coined by William Lowndes, a long-ago secretary to the Treasury of Great Britain who used pence and pounds. Impulse buyers might keep this old maxim in mind while shopping.

Wazoos – Those intellectual, highbrow, disdainful investment advisors who attempt to convince us that investing should not be simple; that they alone can introduce order to the market’s chaos with their complex investment theories.  

Your Age in Bonds Rule – This simple rule of thumb states that whatever your age is should dictate the percentage of your portfolio that should be in fixed income (bonds). The rest would be in equities (stocks). In short, a person aged 65 would have 65% of his/her retirement portfolio allocated to fixed income (bonds).

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