Compounding Wealth (and Wisdom)

inancial planning, compound interest,

By Mark N. Petersen, CPA, CFP®, Vice President of Affluent Wealth Planning

Jazz legend Miles Davis said it well when it comes to music and investing: “Time isn’t the main thing. It’s the only thing.” Time is central, whether in growing wealth or accumulating wisdom. No single strategy works forever, but you also don’t want to change your approach every time the markets shift slightly. 

How does investing work – not just for a season or a year or two, but for a lifetime? 

Interest over Time

Time is a major factor when it comes to successful investing. Compound interest – the ability to earn money on your earned money – is a very powerful concept when accumulating value. 

The rule of 72 is a basic measure of this concept and states that dividing the fixed rate of return into 72 will provide the approximate time necessary to double the value. For example, dividing 7.2% into 72 results in 10 years to double the value. Likewise, the value will double in 8 years when compounded at a 9% fixed rate of return. 

According to the rule of 72, at 7.2% compounding rate, $50,000 would double three times to $400,000 during a 30-year time frame. If given another 10 years to compound (40 years total), the value would double once more to $800,000. 

At a 9% compounding rate, the same 40-year time horizon would include a fifth doubling to $1.6 million while the 30-year investment time horizon would result in $800,000 of accumulated value. 

The more time that money has to work, the more space it has to grow. As you can see, rate of return is another significant factor when it comes to financial planning for a lifetime.

A Portfolio Over Time 

Given the ability to create value over time, one may measure the higher importance placed on a portfolio value after 30 years of investing versus a starting portfolio value. 

Assuming you start with an investment portfolio value of $50,000 and a salary of $70,000, a first-year 20% return would be $10,000, or 14.28% of your annual salary. Thirty years later, assuming a $200,000 salary when the portfolio may have grown to a value of $800,000 (assuming 9% annual return), the same 20% return is equal to 80% ($160,000) of your annual salary, a far higher financial impact, both in percentage terms and absolute value. 

The stakes have gone way up at this point in the wealth journey, and the approach to wealth needs to change.  

Not a Young Person’s Game

As financial advisors, we consider this stepping up to the “Big League.” Much like selling a business, mistakes may be critical at this level of growing wealth and recovery from a misstep may be more difficult. You could have to: 

  1. Increase the risk profile within your portfolio
  2. Delay retirement
  3. Pare back on lifestyle 

We can see then why managing downside risk in an investment portfolio becomes more important as we get older. I think of it in terms of physical aging. In my experience, aging does not impair my ability to accomplish various tasks, what changes is:

  1. My endurance
  2. The length of time I need to recover
  3. The fragility of my body to withstand major impacts (real injury is more likely) 

My brain may tell me I’m the equivalent of 40-something, but experience tells me that I am not, and I should not try to do what a younger person may accomplish. With age truly comes wisdom! 

Hard-Won Wisdom Passed On

As the Advance Solutions Team continues to expand at Carson, the elder and more experienced Financial Planners have the opportunity to pass their knowledge and experience on to younger financial planners. 

The planners and our clients benefit from the lessons learned with age, without having to experience those lessons, personally. Alumni of the school of hard knocks should always try to make it easier on the incoming class. 

This becomes even more important as investors reach that later stage in financial planning for a lifetime. You eventually realize your career won’t last indefinitely and that life is going to change. As the fourth quarter of the game winds down, each second of play becomes crucial, and that’s when an experienced coach can help you keep calm and carry on.

Call your Wealth Advisor to get started on the strategy that’s right for you, no matter where you are in the game. 

CTA: Let’s talk!

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