Big Things Come in Small Packages
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The power of compound interest is a broadly understood and well-documented phenomenon. I learned about compound interest and how it applies to personal finance early on in my financial planning training, but I recently came across an extreme example of it that took my appreciation of its capabilities to a whole different level. My story may open your eyes to a unique planning opportunity for your family.
My youngest son is eight years old. In 2018, he had the opportunity to earn his first paycheck through a small speaking part in a TV series filmed in Albuquerque. (The show, “Chambers,” just released a few weeks ago). I couldn’t believe he earned $1,000 for less than half a day’s work. After giving him the obligatory “Do you know how much I made at my first job?” speech, I began to think of ways to use his recent windfall to introduce him to principles of finance that I employ with my own clients.
It was the perfect opportunity to introduce him to the stock market and begin the conversation about long-term savings. Many people don’t realize that minors can save in a Roth IRA as long as they have earned income. The earnings on the Roth IRA will be tax-free, as long as the account is held to the owner’s age 59 ½. For our situation, the Roth was a great option.
The financial nerd that I am, I started to wonder, “What does $1,000 become at a 9% return over 60 years?” When I did the math, my mind was blown. I’ve seen compound interest work its magic over 10-, 20- and 30-year periods, so I was expecting a big number. But I didn’t expect this:
$176,031.29
That’s right. By starting very early, compound interest’s magic is unbelievable. I ran an alternate scenario where the investment only grew at 6% per year. The results were a “measly” $32,987.69 over 60 years. Starting early is great. Starting early and investing for growth is incredible.
I suggest those of you with children and grandchildren consider this opportunity when they begin their first job. Be creative. Have fun with it. Use a new retirement account to teach market lessons. Maybe start simple with a broad-based mutual fund. As the account grows, let the child help pick out a few individual stocks. Study the companies together and see how they change over time. Let them make small mistakes. I funded my son’s Roth from my own income so he could allocate his first paycheck to spending and short-term savings. Prefer your kid to have some skin in the game? Illustrate the power of compounding, then offer a match. For every dollar they put in, you match it with a dollar of your own. Keep in mind, you cannot contribute more than they earned in the year, and the 2019 maximum contribution is $6,000. And don’t forget to give me a call in 60 years and let me know how it turns out.
Any opinions are those of Brian Cochran and not necessarily those of Raymond James.
This is a hypothetical example for illustration purposes only and does not represent an actual investment. Actual investor results will vary. Investments involve risk, and you may incur a profit or a loss. Non-qualified distributions from a Roth IRA are subject to taxes and possible penalties.
Investors should carefully consider the investment objectives, risks, charges, and expenses of mutual funds before investing. The prospectus and summary prospectus contains this and other information about mutual funds. The prospectus and summary prospectus is available from your financial advisor and should be read carefully before investing.
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