Investing one cup at a time
The above headline comes from an article written by Scott Burns of the Dallas Morning News on Sept. 14, 2003. Those of you who have attended my investment education lectures at the Avon and Vail libraries and/or have been in my retirement-plan investing classes will recognize the author’s name.Since 1985, Burns has been writing one of the best personal finance columns for the Dallas Morning News. I discovered his words of wisdom in the mid-1990s and have been recommending him highly ever since to investors no matter what their level of experience. Log on to http://www.dallasnews.columnists and click on the smiling face of Scott Burns to read his articles.In the article in question, Burns weaves together a narrative that has its origins in a Starbucks coffee shop – hence the headline – and is one of the best illustrations of the power of investment compounding I have ever read.Having asked for and received permission from the Dallas Morning News to use Burns’ commentary, I’ll pass along a condensed version of his story to you.Miracle of compoundingFirst, if you are going to invest for retirement legions of financial writers and investment adviser – as well as their various publications – have told you that one of the keys to building a nest egg is to start saving early and regularly. As we shall see in Burns’ story, because of the miraculous effects of compounding over a long period of time, this self-evident advice produces truly spectacular investment results.Just what is this phenomenon and how does it work? The textbook definition of compounding is fairly straightforward: The investment return earned in one period – a day, month, or year, for example – earns an additional return during each subsequent time period. For example, banks have been compounding interest daily on customers’ CDs and time deposits for decades. The keys to achieving meaningful investment results are to maximize the length of time compounding has to work and to keep investing a fixed-dollar amount on a regular basis. Novice investors are probably tired of this mantra, but long-term compounding of invested funds is an absolutely essential retirement investing habit. Let’s take a look now at what Burns has to say about all this. Latte growth fundHe begins his tale in Starbucks surrounded by young people, mostly in their 20s and 30s, and wonders “whether they were drinking lattes, cappuccinos and other concoctions instead of saving for their distant, wrinkled futures.” Burns asks himself, would giving up a daily indulgence – a latte, cocktail, candy, snacks – make them millionaires?Sounds like a pretty far-fetched idea, but let’s take a look at Burns’ idea for putting this concept to work in a “latte growth fund.”Here are his basic premises: A latte habit costs about $3.50 daily, $24.50 weekly and $105 monthly, which amount to about $1,278 a year. You invest this money – instead of drinking coffee at Starbucks – at a long-term average annual return of 10 percent over a 42-year period (assuming full retirement age for Social Security will probably be 67). Lastly, you’re 25 years old earning $30,000 annually and inflation averages 3 percent a year. Both income and the latte cost rise with inflation. These are reasonable assumptions – the average return percentage may be a little on the high side, but it’s doable.At the five-year and 10-year marks, Scott Burns’ latte growth fund amounts to $8,650 and $23,959, respectively. After 25 years, the dollars, $167,564, start to get serious. Then the fund balloons to $805,087 after 40 years. At age 67, after 42 years of regular investing and compounding, you hit the jackpot at $983,614 the ex-latte drinking investor is almost a millionaire retiree.The Investing Wisely column is written by Richard Loth, managing principal of Mentor Investing, an independent registered investment adviser. Loth can be reached at (970) 827-5591 or firstname.lastname@example.org.Vail, Colorado
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