Investing and playing with numbers
Investing is fun, especially when your selections grow in value. Investing involves risk and, because there is risk, patient investors tend to do very well. Impatient investors, those perhaps frightened away by the market’s occasional significant downturn, don’t agree that investing is fun.
Many savers are reluctant to invest because they don’t feel they can afford to take risk. Yet, one significant risk for savers is the earnings rates in safe deposits are not great enough to allow for the attainment of anyone’s goals.
Financial advisors use a process to help their clients consider their goals and personal risk tolerance. Then they gather information of existing holdings to take an assessment of where they are today, including what they have working already. Finally, the advisor prepares a formal report that includes suggestions of what steps might be taken to move closer to the goals. This process is revisited each time they meet to help make the appropriate adjustments and modifications.
Investing starts for many people today with the retirement plan through work. These plans are more and more contributory plans where employees can allocate a portion of their earnings to the plan pretax. These plans often have a menu of investment offerings each employee selects from. Most private sector employers no longer offer pensions. Most government workers have pensions and may also participate in a pretax retirement offering. Workers that do not have a plan offered through work can save on their own in IRAs — Individual Retirement Accounts.
What are some of the variables that will influence the likelihood of reaching the retirement goal? How long you work. How much you save. How well your savings and investments grow. How much you need for other goals. How much you already have saved and invested. How good you are at sticking to your plan and leaving well enough alone. Your good health and hard work. Your progression in your profession. How specialized your education or skill set positions you to earn a better income. A better income allows for higher savings.
Many of my clients have been people of significant talent and expertise in their profession. Lawyers, accountants, teachers, principals, grape growers, winery owners, business leaders, doctors, and dentists. Many invested towards retirement and many invested to diversify away from their primary working situation and assets.
One of the most important financial life tools to have at the ready is the rule of 72. This is a great math trick to know and apply to all of the choices you make about where to have your money. Dividing 72 by your earnings rate will tell you how long it takes for that deposit to double.
Today the safe earnings rate on savings is less than 1% and time deposits don’t offer 2%. Using 2% as a projected earnings rate on a deposit today, divide 72 by 2 and 36 comes back as the length of time to double.
Ten-year U.S. Treasury notes are offering just over 4% today (72 divided by 4, 18 years to double).
The stock market over the last 10 years has returned a bit over 8% (72 divided by 8, 9 years to double).
By the way this math tool works just as well on interest calculations that you are paying, like your mortgage, car loan or unpaid credit card balance. According to the American Bankers Association the unpaid balance on credit cards in America is currently $682 billion, an average of $16,000 per household. The average interest is a bit over 17% (72 divided by 17 is about four 1/2 years). That means you pay twice for that debt in just over four years. Yikes.
These quick calculations using the rule of 72 help us make better choices. This is why many investors are not borrowers. They have learned that saving and investing comes after paying off debt, especially those too expensive credit cards. Dave Ramsey is a popular financial advisor who offers great tips on how to get out of debt and on the path to financial success.
Another number that can be very useful in decision making is the future earnings growth estimate for business. It may interest you to know that the projected future earnings growth of the companies in the S&P 500 over the next 10 years is about 7% (72 divided by 72, 10 years to double).
Included in the S&P 500 are companies that are projected to grow earnings at less than the average and some that are projected to grow faster. By the way, most people don’t venture into individual stock investing until they have significant other savings and investments. I would suggest considering individual stocks when you have a minimum of $25,000. This amount allows for six to eight stocks, giving an opportunity to reduce risk and provide a beginning diversification.
Some companies have future earnings growth estimates at over 10%, some even as great as 25% per year. There are over 50 companies today at the over 10% threshold and many of these businesses have enjoyed growth in value at rates much faster than the market.
Another interesting aspect to investing in things that grow is that the growth isn’t taxed until you sell what you own. This is the same way all capital assets are taxed; real estate, business, farms, and stocks. And the tax rate when you sell is about half the rate of earned income.
Warren Buffet is famous as one of our country’s most successful investors and he has said his first rule of investing is to never lose money. He is also known to have his holdings entirely in stocks. Perhaps a lesson or two to take to heart.