Compound Interest Doesn't Add Much To Your Wealth
The biggest gripe that I have with a few famous financial
planners is their myth and awe of compound interest. They say,
"compound interest is the 8th Wonder of the World according to
Einstein, and will make you a million for your retirement if
you'd only skip a few trips to your local coffee shop!!" In my
opinion, compounding your return on investment is a tiny factor
in wealth building compared to how much and how often you save
money.
Growth charts used by the people struck by compounding ignore
all forms of taxation, fees, commissions, inflation, and then
misleadingly uses an average return of 10-12%. Let's start with
the average stock market return of 10.7% This return rate is the
most frequently published number to reflect a stock market
average. There are many problems with market averages, but the
10.7% is not any kind of accurate annual compounded growth rate.
As an example, if the stock market has a loss of 10% one year,
and a 20% gain the next year, these zealots say that the average
return for these two years is +5% (+.2-.1)/2). This is a
mathematical failure to add. The correct return is only 3.9%,
and again, this doesn't include fees, commissions, taxes and
inflation. How are you going to compound your money when the
stock market starts one of its frequent 5 year droughts of
moving down and sideways ('73, '81, '87, '00). The
after-inflation Dow Jones Industrial Average annual return for
the last 55 years is only 4.8%; plug that little number into
your calculator for 10 years and see how many Rolls-Royces you
can buy.
Your growing portfolio will either be in a taxable account
(knock another 25% off of your annual compounded growth rate for
taxes) or in a qualified retirement account. The zealots talk
about qualified accounts like everyone can have them, but there
are mazes of rules for who can qualify for certain programs, how
much they can invest, and even a ceiling to how much can be put
in them. Sooner or later every dime of these accounts will be
taxed as well. And when the baby-boomers start emptying the
government's social security account in 2014, tax rates on these
retirement accounts are not going to remain low. Politicians
will take the easy way out and simply tax these retirement
accounts to make up any deficit. The point is this: when money
is in a retirement account, it isn't yours until the government
taxes it and releases it to you. More reference material for
this article is available at
http://investing.real-solution-center.com.
If you start playing around with realistic compound rates, the
serious increase in earnings doesn't start until after 50 years.
So unless you are a 4 year-old with $50,000 in the bank and have
the discipline to never spend it, even the concept of
compounding is fairly irrelevant for your financial future.
Today, half of the 50 year-olds in the U.S. do not have $50,000
in retirement assets. Even skilled investors are unlikely to
build that into a tidy $2,000,000 by the time they turn 65.
The compounding that pays the most is the addition to your
savings over time and investing skill. If you don't continually
add to your accounts, they can not add up to much; "No big money
in = No big money out." And if you don't continually accumulate
investing skill and knowledge, you won't be able to keep your
money growing faster than inflation is destroying it. Please
note that there are no books titled "How To Get Wealthy By
Putting Some Money Under A Mattress." Your money has to be
invested and earning interest above the inflation rate or you
are getting poorer.