Imagine this: You are a young, vibrant 23-year-old who has just landed your first internship or corporate job and wondering what’s the best way to handle your salary while planning for the future. Or you could be a 40-year-old married mother (Mrs 40) of 2 looking to balance the family budget. You could even be a smart 17-year-old hoping to be the next Bill Gates or Warren Buffett.
What’s the one major ingredient that is absolutely essential to guaranteeing your long-term financial happiness, regardless of who you are? Savings do help, but inflation and unexpected emergencies will chip away at the value of your money. Sure, you could place a huge bet on the lottery and become an overnight millionaire, but the odds of you winning are incredibly slim.
The answer, as demonstrated by successful people worldwide, is investing wisely and starting early. From 1 July 2017, Singaporeans can expect to work up to age 67, while nearly a quarter of Americans plan to retire at age 70. Yes, people in developed countries are retiring later than ever. Assuming a retirement age of 67, this means our 23-year-old will have 44 years to plan for retirement, while Mrs 40 will only have 27 years. Never fear, for she can still plan for her children’s future! Naturally, the bright 17-year-old stands in pole position, with an astounding 50 years to plan for!
My Story: How I Learned about the Time Value of Money
You may have noticed that I placed a lot of emphasis on the amount of time that you have before you get settled into that comfy retirement village (possibly across the Causeway). This is where I shall introduce my dear friend, the Time Value of Money (TVM). Simply put, a dollar now is worth more than a dollar in the future.
I encountered this concept initially while I was still studying in Junior College, but it was not until I actually began planning for my future that I came to fully appreciate it. Having landed an internship at a bank, I found that I was now in possession of a decent cash stream. As long as I fulfilled my obligations as a good employee, my bank account numbers would miraculously rise every month! Being a future-oriented person, I began contemplating my career path and indeed, how to best secure a comfortable retirement.
In order to “predict” my financial future, I pulled out my trusty financial calculator and performed a few simple calculations. Let me invite you to join me on this exercise. You may use an online TVM calculator, your own financial calculator if you have one available, or this Android calculator app that I have found to be most effective. We will perform these calculations from the perspective of the 23-year-old.
To begin, set the periods to be monthly compounding.
Let the Present Value (PV) = $5,000. (representing your savings)
Interest Rate (I/Y) = 5%
Monthly payments (PMT) = $1,000
Number of periods (n) = 44 years * 12 = 528
Computing FV gives us $1,961,045.
In other words, the 23-year-old would have saved up nearly $2 million by wisely investing his savings at a conservative 5% interest rate!
Performing similar calculations, Mrs 40 would still be able to earn an impressive $702,422 over 27 years. The precocious 17-year-old, with 50 years to invest, would end up with a cool $2.7 million!
At this point, you may be questioning some of my assumptions. Would a married mum really be able to squirrel away $1,000 every month? Could a 17-year-old student really have $5,000 in savings and save $1,000 every month?
Fine, let us adjust our assumptions for realism. Assuming Mrs 40 can put away $300 every month and begins with zero savings, she would still be able to earn over $200,000 by age 67. Compare this to keeping it in a bank at an interest rate of 0.1% per annum (p,a,), which gives her $98,520 at the same age. That’s over $100,000 lost, simply because she had failed to invest it properly!
Our 17-year-old has a far longer investment horizon and can therefore afford to go for greater returns at the cost of greater risk. Let’s assume he can reach a rate of 8%, but start with no savings. (Take a deep breath now, for the next sentence may take your breath away.) This leaves him with a cool $7.9 million! That’s $5.2 million over his savings with an I/Y of 5%, and $7.1 million earned over keeping it in the bank’s checking account! This is a perfect example of how a seemingly small increase in interest rate can truly add up to astronomical sums over the years.
Think of what you can buy with a million dollars! Now, what would you buy with seven million dollars?! Let your imagination run wild. A bungalow with a pool, with a Lamborghini or Porsche? Multiple Birkin bags, or luxurious LV shoes?
But how can we go about earning a 5% rate of interest on our money, let alone 8% or more?! This brings us to the real secret. Read the next section very closely, and digest as much as you can, for it may prove to be vital to your future success.
The Open Secret: Investing
The key to attaining an 8% rate of interest lies in proper investment. By having a proper portfolio of stocks, bonds and investment products, our 17-year-old can easily reach this interest rate over his long investment horizon. He needs to be well-prepared for short-term fluctuations in his portfolios, however, and not bail at the first sign of trouble.
On the other hand, Mrs 40 has a shorter investment horizon and more commitments, and she would be wise to invest it in a mixture of government bonds and insurance products, which would allow her to reach her desired rate of interest at lower risk. More detailed strategies will be covered in future posts.
Your future happiness is at stake. Don’t leave it up to chance. Start investing now.