The 9 Steps to Financial Freedom (26 page)

If you start ten years earlier, at thirty-five, your $100 a month will have grown to $101,000 by age sixty-five.

If you can start saving $100 a month at age twenty-five, you will have $200,000 by age sixty-five.

Time accounts for the difference. By waiting twenty years, from age twenty-five to age forty-five, to start saving just $100 a month, you pass up more than $150,000.

Time plays an essential role in building your future wealth, not only because the longer you contribute, the more you’ll have, but also because with time, the contributions you have already made will do more work for you. This second feature that makes time so powerful is called
compounding
.

When you leave your money invested over time, the amounts of money that your contributions are generating on their own are the worker bees of your money hive.

For instance, let’s say you are investing $6,000 a year, and that $6,000 is earning 6 percent. Let’s assume that your investment will be able to average that 6 percent over the next twenty years, and that you continue to add $6,000 at the beginning of every year as well. There will come a point in time when the earnings on your account will add up, by themselves, to more than the $6,000 you are putting in every year. This is when those worker bees really start to make that money honey.

Take a look at the chart on the following page and see how many years it takes before you are earning as much in interest as you are putting in. Look a little farther down the road, and you’ll see that in just a few more years you could be earning two times more a year in interest than what you are contributing!

Why? Because of the magic of compounding. It is for this reason and this reason alone that you cannot afford to let one year pass without making a contribution into your retirement plan. When it comes to the wonderful effects of compounding, you can never make up for lost time. This is why in the example just given, twenty years makes such a tremendous difference in what you will have in the end: more than $150,000 worth of difference.

This table illustrates the power of compounding at a 6 percent return; the higher the return, the better the results. In this case you have invested $120,000 over these twenty years. At 6 percent throughout, you have earned $114,000. You have earned, in other words, nearly as much as what you put in! Compounding is extraordinary, and the main ingredient of compounding is time. Give yourself that time.

Whatever your return, you can’t afford to miss out on the golden opportunity that time allows. You work so hard for your money. Now let your money in return work hard for you.

Start training yourself to understand not just what your money is worth today, but what that same money will be worth in the future. Like a slide projected on a screen, your money becomes much larger over time. Consider the “big picture”—that compounded future value—when you are looking at the money you could save or spend today. Whenever I had a client come to my office who wanted to do something that day that would cost a lot of money, I always calculated what it would really cost by looking into the future. That’s the true cost of today’s desire.

I once had a client come in and say, “Suze, I want to take a year off work, and $20,000 out of my savings, to go live in Europe for a year.” No problem, I said, as long as she could understand what that meant for her future. That $20,000, if left invested at a 6 percent annual return, would, in twenty years’ time, when she turned sixty-five, be worth $64,000. Did she feel comfortable spending $64,000 to take a year off, not to mention the money she’d lose by giving up a year’s salary? “But Suze,” she said, “in twenty years $64,000 won’t even be $64,000, because of inflation.” But using a 3 percent inflation adjuster, in twenty years that $64,000 would still be worth $36,000. The trip would cost her $36,000.

It is so important to see what things are really costing you, and the way to see this is to see money over time. It is when you start looking at money like this—finding out how what you do today affects your future before making your decisions, which
must be based on reality and not just on hope—that you will really begin to understand money. Desire the trip, understand what it will really cost, decide whether you can afford it, and if you can, then take it by all means. Or scale it back, if that makes more sense. Or wait a year. If not this year, then the right actions with your money will still get you to Italy next year or when the time comes.

And when you’re doing the right things with your money, when you’re being respectful, the right time will always come.

One thing that your mind will try to tell you is that when you invest money, whether in your retirement account or on your own, you have to keep it safe and sound, that you can’t afford to take risks with it. Wrong. The truth is that you really can’t afford not to take risks. You
have
to invest this money for growth, especially if you are under the age of fifty. The younger you are, the more aggressive you can be.

As long as you have at least ten years during which you won’t have to touch this money, invest the majority of it for growth.

Put your money in whatever stock or equity mutual funds your 401(k) offers. If you are in a SIMPLE, IRA, SEP, or Keogh, and just want to keep your life as easy as possible, look into good no-load index and managed growth mutual funds (
this page
) as well as exchange-traded funds (ETFs). Your investment mix can also include a small percentage in international growth funds if your company offers it. Over the years, stocks
or equities have outperformed every other investment out there—so again, the younger you are, the more aggressive you can be.

When you start approaching retirement, and know that you will soon be living off this money, it’s time to consider easing up on your more aggressive investing. Even so, it’s always best—and perfectly safe and sound—to have a nice mix of funds and keep your money diversified.

Of course you don’t, nor does anyone want you to. When you begin paying yourself every month, as you do with a retirement plan, not only do you get more long-term bang for your buck, you also take some of the risk out of investing this money. So you don’t have to be afraid. When you put the exact same amount of money month in, month out, into the same investment vehicle, you are taking advantage of the investment strategy known as
dollar cost averaging
. It puts time, your money, and the market all on your side at once. (We’ll talk about this more later.)

I believe this with all my heart, but regardless of what I say or what anyone says, you should invest only if you want to. The reason I say only if you want to is that even though investing for growth may be the right thing for you to do economically, it’s not the right thing to do if it keeps you up at night worrying or makes you afraid all the time. As you’ll see in the next chapter, you must always trust your own gut feelings about money. If you can’t live with risk, you must invest where you feel safe investing. Perhaps your new truth will make you feel stronger about taking risks. Maybe reading throughout the rest of this book will make you feel differently
about risks and your fears about money. But respect yourself first, and however you choose to invest, take care to understand how things work—or you might end up doing what Michael did.

With time on your side, you win when the market is up—but you also win when it goes down.

Michael’s trouble was that he understood only the concept that when you buy something you want it to go up, better known as “buy low, sell high.” He didn’t understand that what you want to do with dollar cost averaging—which is what you’re doing with a 401(k)—is to buy low and lower and lower and
then
sell high. Michael had actually chosen a great fund to invest in, and since he had many years left until he retired, he should actually have been thrilled when it took a tumble. But no one told him that.

With dollar cost averaging, you are taking the money you’re investing and averaging the cost of the shares you’re buying over time. Since you are investing every month, wouldn’t you rather buy into your funds when the market is low, so you don’t have to pay so much for your shares? Of course you would. When what you are buying goes down rather than up, that means you’re paying less and are able to buy more. I always think of it as a mutual fund sale—getting what I want for less than others had to pay just a few months earlier. Michael got upset because the shares he bought went down in price over a few months. Had he stayed in for the long run, however, he would have made everything back plus more when his mutual fund started to climb again.

When I say you should be happy if your fund starts to go down as you’re buying it, I mean be happy if all the funds that are similar to yours are also going down. You want to make sure that your 401(k) plan, and any other mutual funds you hold, are with a good portfolio manager (
this page
), one who is able to do as well as or better than other comparable managers. If your fund is going down and the others are all going up, then you do need to take action; check with your human resources department. If the market starts to go down, just keep an eye on your funds to make sure they’re not going down more than other similar funds. If your portfolio manager can keep your money from going down as much as the others in a down market, think what she’ll be able to do when the market goes back up!