“Time Value of Money” is a phrase we often hear, but do we really understand the impact it may have on our lives? In some of my previous articles I have referred to the growth of investments and the potential accumulated value, but it has been a while since I have discussed in detail this concept. Even if you believe you know this concept, take the time to read the following. You may be able to use my example to profoundly impact someone else, such as your child, or even a grandchild.
A visual example of this concept is the mountain chart mutual fund companies create to depict their past earnings. If you are a current investor, you most likely have seen these charts in the annual reports. At first glance, these often appear very impressive. The graph starts very small on the left side, usually $10,000 is used as the starting value, and the graph builds as you move to the right and years invested increases. The end result is the mountain and hopefully the creation of the desire for you to invest.
The mountain image does depict an excellent example of “Time Value of Money.” As the time invested increases, this provides a greater opportunity for small and large gains in the market to impact larger and larger investment values.
As an example, if the market were to increase by fifteen percent in a given year, a beginning investor may not be all that impressed with their gain if their account started the year with $10,000. Their return would be $1,500. Compared to today’s annual income requirements, this amount hardly comes close. But what if, you had already been investing a number of years and your account at the start of the year was $400,000? If you earned the same fifteen percent return, your earnings would be $60,000! The same return but a dramatically different result. The result is also what creates the steepness of the mountain on the performance charts. And when the annual returns are even higher, the visual image of the mountain chart is more dramatic.
These charts I have been discussing generally cover ten years, but what if the time period was extended to forty, fifty, or seventy years, such as the investment timeframe of young adult or teenager. The ending value can often encourage even the biggest spendthrift to start saving.
The table on this page does not represent any particular investment but does show the growth of $500 per year at various rates for up to fifty years. This has never failed to excite most young adults I have spoken with. When I ask if they think they will be making more money after they have been working for a while, they all say yes. I then explain the following results would be much higher if they were to increase the amount invested each year as they earned more money; their resulting eagerness continues to grow as well.
Time can be more important than the amount. For example, an investor saving $2,000 per year from age 20 to 30, but then stops adding to the account, will have over $428,000 at an eight percent return when they reach age 65. Even though they only invested $20,000, the time available for growth makes the difference! Let’s consider a second investor who starts investing at age 30 and invests the same amount each year until they reach age 65. They will achieve only a value of $344,000 by age 65 earning the same eight percent return. While the second person invested more than three times the amount of money as the first investor, the amount of time was not in their favor. Starting to invest today is always better than waiting.
For help with managing investments contact me at Quality Financial Concepts or one of the other Certified Financial Planners in our area. To continue a personal quest for education, you can also view our website, www.goqfc.com. There you will find articles on a variety of topics, on-line seminars, calculators, as well as a host of other tools all available for free.