When you begin investing, there are a lot of fancy phrases that will be thrown in your face. But, don’t get overwhelmed. Every industry, in an attempt to exclude outsiders, creates their own, over-cluttered codification full of unnecessary jargon and ridiculous acronyms. From cost basis and back-end loads to NAV’s and the NYSE – the investment industry is no exception.
For the individual investor who has little desire to learn a foreign language and whose primary concern is “to retire one day,” here are only 3 definitions to familiarize yourself with:
- Time Horizon
- Risk Tolerance
- Asset Allocation
In layman’s terms:
- Time Horizon – how long your investments can go untouched
- Risk Tolerance – the ups and downs you can stomach
- Asset Allocation – split between asset classes (stocks, bonds, etc.) to balance risk and reward
To bring everything together…
Your time horizon plus your risk tolerance will determine your appropriate asset allocation
…and these 3 variables, among others, will ultimately decide your investment returns.
Pretty simple, right?
“Time, Why You Punish Me?” – Hootie & The Blowfish
Although all 3 variables are important in their own right, today I want to focus on TIME. If you decide to invest early in your career, TIME will be your best friend. But, if you continually put off investing – as Hootie so eloquently eluded – time will punish you.
Thanks to the TIME VALUE OF MONEY and COMPOUND INTEREST, $100 today is worth more than $100 a year from now.
Because $100 today can be invested (earning roughly 1%) and would be worth $101 a year from now. Therefore, as stated above, $100 today is worth more than $100 a year from now.
To illustrate the impact that time has on an investment portfolio AND as a way to nudge you to start investing today (rather than procrastinating like you usually do), I am going to show you how delaying action by a decade affects your future balances.
How Investing $10,000 Differs at Age 20, 30, 40, 50, and 60
- John invests $10,000 at age 20.
- Paul invests $10,000 at age 30.
- Mark invests $10,000 at age 40.
- Ringo invests $10,000 at age 50.
- Whoopie invests $10,000 at age 60.
Each of the Beatles above (and Sister Mary Clarence) invested $10,000, but look at how different their balances are at age 70.
(Assuming a 5% annual return with no additional contributions)
- At age 70, John has $121,193.
- At age 70, Paul has $73,584.
- At age 70, Mark has $44,677.
- At age 70, Ringo has $27,126.
- At age 70, Whoopie has $16,470.
By delaying the same $10,000 investment by 10 – 40 years (which, quite honestly, is very easy to do), the difference of future balances ranges from roughly $11,000 to $105,000.
The next time you tell yourself that “you’ll save more later” (because there’s something else you want now), remember that you’re making your future self poorer and poorer.
Ask yourself: “would I rather save $10,000 today or $100,000 in a few decades?”
The answer seems pretty simple.