Why You Must Use THIS

Why You Must Use THIS

I am going to show you a problem that most people have and then give you a solution. The solution will be the THIS that I spoke about in the title.

Suppose you want to retire some day. Suppose you want to own your life and your time and not have to go to work for eight or more hours a day five or more days a week. Play with your grandchildren, eat breakfast with your spouse, travel and see the world, drink iced tea in the back yard, that sort of thing. Perhaps you become ill or disabled and can't work. So just for fun, let's say you want to retire at some point and not work every day until they call the undertaker for you.

This is only an example and I will pick a rather worst case scenario and all the while, remember the financial planners and the investment people have the disclaimer that “Past performance (or in other words history) is no indicator of future performance,” but we really don't have much more to go on and in things like the sun rising in the east and Spring following Winter history has a pretty good track record.

Suppose you started to work at the age of 25 in 1975 and 40 years later you wanted to retire in 2015. According to the people that keep records on these things and their best figuring, about $10,579 was the average U. S. household income in 1975. It is hard to find some numbers for 2015 that haven't been tinkered with too much since even the Government has an agenda, but a little searching and pencil work makes it look like about $56,000 was the average or median U. S. household income in 2015. Which means in the last 40 years average income has gone up about 5 times, actually a little more with these numbers.

What does this mean? A lot of things, but one thing is, if you were making an average living in 1975 and you wanted to retire on an average income in 2015 you would need something like 5 times the money….every year.

Looking back at some prices I see that coffee, sugar, houses, they have gone up about five times in price since 1975 and cars are more like eight. To make it worse, that isn't correcting for the difference in the value of the dollar, which has dropped since 1975. If you correct to 1975 dollars can make even a bigger difference.

If in 1975 you put your entire income for a year in a box and said to yourself, “I will live on that when I retire in 40 years” when you open the box 40 years later you will find that year's worth of wages in 1975 will allow you to live at an average income level in 2015 only about two months and two weeks. Five years of 1975 wages put in a box in 1975 will allow you to live only one year in 2015 at the average income level.

To make matters worse, almost everyone that figures these things say that wages haven't kept up with inflation, or in other words middle income people in 1975 could buy more of things like food, houses and cars in 1975 than middle income people in 2015 can buy.

This is sort of a worst case example and even it ignores a few things, like we have a lot more things to buy these days like cell phones and wide screen televisions that people in 1975 didn't have to budget for, but it should paint a picture for you.

On the positive side in this example, if you stayed in the middle class with a middle income, your wages would rise over the years making it easier to put more money into retirement, but that only helps a little when you can't put a year of wages into your retirement fund every year. You have to live on something now.

So what is the answer? For many people it is compound returns or compound interest. They say that when Einstein was asked what is the greatest force in the universe he said,  “Compound Interest.”

Let's run some more numbers. How many years do you expect to be in retirement? If you retire at 65 you could easily live to be 85 and that would be 20 years. You could live to be 100! That would be 35 years. The answer is you don't know how long you will live, so you don't know how long you will be in retirement.

The answer to that question is to have a retirement fund that you can draw enough money off of to live and it makes money to replace that and cover inflation. You hear talk about a sustainable world, you need a sustainable retirement fund!

There are two things your retirement fund should do. One is grow during your work years at a rate that when you retire you have sufficient funds. The other is continue to earn money to replace what you spend and cover inflation. What would you say about your morning coffee? Do you think it will cost you more when you are 100 than when you retire at say age 65? If history is any factor, then it will cost something like four or five times as much and so will most things. You see, inflation is actually built into our money system. It is just like a new car comes with tires. It is designed right in.

Back to compounding. The old example is doubling a penny. Would you rather have a penny doubled every day for 30 days or a million dollars? It turns out that if you double a penny for 30 days you will have more than a million dollars, you will actually have more than 10.7 million dollars. Not many people can write that check if they take the bet.

With inflation the power of compounding is working against you, but when you invest in something that earns you money and then put the original amount or principle back into investing along with the amount earned you have compounding working for you.

For just one example, this is why investing in houses where the rent pays for them and the house appreciates in value while you reinvest any surplus money has made many people rich. Jim Rohn said he teaches children this. You have one bicycle to ride and one to rent. One home to live in and one then two and then more to make money.

Banks just don't pay much in interest, so don't think you can park your money in them and retire. Here is a rule for you to see how long it takes to double your money at a given interest rate or fixed rate of return: Divide the rate of return into 72 for an estimate of the years it will take for your money invested and reinvested to double.

This is just a usually close estimate, but financial people use it all of the time when they don't have those fancy calculators at hand. Suppose you want to see how long it would take to double your money investing it at a 9% rate of return. Divide 9 into 72 and you get 8 years which is close enough for most purposes, the exact answer is 8.0432 years.

As I am writing this the average CD rate on a five year CD is 0.86% which means you would need over 90 years to double your money and a cup of coffee is likely to have gone up in price by a factor of ten or more by then.

Hopefully you have seen the advantage in using compound returns with your retirement funds to build wealth for your retirement. I am not a financial adviser or professional, so what you do with this little discussion is up to you and I strongly suggest, even insist where there is risk involved you must consult with a professional. I can't be responsible for your results if you try to follow these hypothetical examples.

When you are enjoying your Iced Tea in retirement, think of me.

Best and be blest,
Scott Hogue CChH