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Investing Less, Earning More

Could investing $13,000 be better than investing $70,000? In this case, the answer seems to be yes.

In Making Money Made Simple, Noel Whittaker compares two hypothetical investors:

Person 1: Invests $ 1,000 a year from age 18-30.
Person 2: Invests $ 2,000 a year from age 30-65.

You might think that person 2 would be better off, but here's how it goes (in chart form):


Person 1 stops investing at 30, but their investment keeps growing. At that point, person 1's yearly growth is more than person 2's yearly contribution. That's why person 2 never catches up.

Person 1 ends up about $ 150,000 ahead, despite investing about one-fifth of what the person 2 invested.

What if growth isn't so good?

These calculations assume 10% growth. What if it isn't that high?

Fair point. I've run the numbers at lower rates of growth. At 9%, person 1 is still better off. At 8% it's close, and person 2 comes out slightly ahead. But that's not really the point.

One investment is one-fifth the size of the other (smaller contributions and a shorter time). The fact that this is anywhere near a close finish is mind-boggling.

Person 1 has earnt about 50 times their money back. For Person 2 it's less than 8 times. That's the benefit of starting early.

It's the tortoise and the hare

If you measure from when each person starts investing, person 2 does go up more quickly. But person 1 is further ahead because they started earlier and just kept going.

For instance, after 35 years of investing person 2 has about half a million. Person 1 had just $200,000 after 35 years of investing. It's a slower initial rate (like the tortoise) but because of the earlier start, they still had another twelve years of growth to come.

The maths of compound growth means that the bulk of the earnings come in the later years. The earlier the start, the more productive those later years can be.

What if I'm older?

If you're in your 30s or 40s, you might be cursing your luck. But the principle still holds for you - better to start now than wait until 55.

If you're 45 or older, perhaps show this concept to your teenager - if they're interested in making hundreds of thousands of dollars.

If you're a teenager or young adult, then congratulations. You have the most important asset. Time.

What else?

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Comments

  1. My mind is always blown when I see these comparisons! I'd love to see another version with actual ages taken out and replaced with "# of years of investing". Less disheartening for those of us who didn't start at 18. :)

    ReplyDelete
    Replies
    1. Hello Michelle.
      Yeah it's tricky. The purpose was to powerfully illustrate the specific example given in the book I'd read. I hoped converting the numbers into a timeline would graphically show that an early investor is always better off (at any point on the journey).
      I considered leaving off the numbers entirely, introducing a third person who doesn't start until 50 (to give heart to the 30 year-old reader) or having a 30-year old starter who catches up by investing even more. But none of these seemed as impactful and clear as the original point - so I stuck with that.
      I thought of making the horizontal axis "years of investing" but thought that would be confusing (as it would end at 47). A great deal of my point is that the early investor does just 13 years of (active) investing and never adds again - that compound growth does so much of the work.
      Having said all that I hope that the 30-something can still see that person 2 still gets a very juicy outcome, from a relatively tiny annual saving.
      I still have plenty more finance ideas up my sleeve for future articles, so I hope you've subscribed :) As someone who's definitely older than 18, I can assure you I'm very much thinking of people who are further along the journey, even if this article was most impactful for people too young to have ever seen a fax machine ;)

      Delete

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