Do you have a long-term saving strategy? If not, now is the time to begin building one. The good news is that it’s not rocket science. All you need are a few pieces of data and a compound interest calculator to get started. What should everyone know before they set out to develop such a plan?
Here’s the shortlist:
- The S&P 500 stock index for the past three decades has paid 10.7% on average
- Gold offers an average annual return of around 10.6%
- Commodities deliver 10.9%, on average, annually
- It’s best to use examples to see what your own returns will be
- Plan to save a fixed amount per month for a number of years
- Use compound interest calculators to measure the returns on various investments
Here are more facts about each point. Use the information below to choose your favorite investment category and set a regular saving amount.
The stock market can be quite volatile, but over time, the major indices, like the DOW, S&P 500, and the German DAX, all tend to deliver relatively decent returns. Of course, investors will have losing and winning years. The goal of long-term investing is to get into the game for several decades and reap the rewards of compound interest. For the S&P 500, one of the world’s most-watched indices, annual returns average about 10.7%
Gold is a favorite investment vehicle for investors who believe that the global economy is in trouble and will not hold up well in the long run. However, gold’s 10.6% average annual return is no higher, up till now, than the stock market or the commodities markets. The example below uses gold as the primary asset.
Commodities like oil, natural gas, corn, and others can deliver solid returns during recessions, but their long horizon is about as attractive as gold and stock indices, coming in at 10.9%. Investors who like to diversify their holdings will sometimes include:
- Two or three commodities
- One or more precious metals
- Real estate trust shares
- Stock index fund shares in a self-directed IRA
Regardless of whether you invest in gold, stock indices, commodities, or something else, the best way to get a feel for how the money can grow is through examples. The following hypothetical scenario uses gold, but it could be anything for which you can estimate the future interest rate.
There are two basic ways of building an investment account. One is to simply make an initial deposit and reinvest the interest regularly. The other is to make an initial deposit, reinvest all interest, and add periodic deposits at regular intervals.
With Initial Investment Only
Suppose you are a gold devotee and prefer to maintain a portfolio of the yellow metal for long-term appreciation. Many people who feel this way open self-directed IRAs that are allowed to hold precious metals. Traditional IRAs can’t hold physical assets of any kind.
Assume that gold continues to post average annual returns of 10.6%. Further, for this hypothetical example, the investor purchases $10,000 worth of gold today and leaves it in the SDIRA for 30 years, adding nothing along the way. What would the account balance be at the end of the three decades?
Here is the calculation, arrived at by using the compound interest calculator.
Remember to enter the beginning amount of $10,000 and the correct interest rate, 10.6%, along with a period of 30 years and no payments (because there are no additions to the account).
The initial investment grew by $227,133.26 for a grand total account value of $237,133.26 by the time the 30 years had passed. You can use simple math to do a quick calculation based on this result. For instance, if you intend to deposit $20,000 instead of $10,000, then the result will be twice as large. Likewise, an initial investment that’s half the size will only be half as large.
With Initial Investment and Periodic Payments
A much better way to amass a large retirement account balance is to add periodic payments to the initial investment amount. Using the above example as a basis, consider what the results would be if the person makes monthly $100 payments to the account.
Then, alongside the $10,000 in gold placed in the portfolio on day one, there would be 12 payments every year of $100 for the duration of the three decades. Using a compound interest calculator, the results prove that even small monthly addition can make a huge difference in the final account balance. Assume the same rate of interest, initial deposit, and rate of return.
The initial $10,000, with monthly deposits of $100, for 30 years, at 10.6% interest, yields a total balance of $494,265.25. Note that the original amount plus the deposits amounted to just $46,000, which means the profit, due solely to the stated interest rate and compounding, was $448,265.25.
It’s clear that a small monthly payment can greatly augment the final balance of any long-term account. That’s the beauty of compound interest. It has a way of super-charging ordinary investing tactics and delivering amazing results.
Is There a Best Saving Strategy?
The short answer to the question about whether there’s a best way to save is “No.” The longer version of the response is that no one can be sure if future returns on various categories, like stocks or gold, will be the same as in the past. Investors should choose one or more assets that they feel comfortable with.
A popular choice is to set up a self-directed IRA that can hold precious metals, real estate, stocks, and other non-traditional assets in order to achieve diversification. The other piece of the savings puzzle is aiming for the long horizon. Younger people who have the advantage of time can put money away for several decades and let compound interest do its magic.
If you’re able to save consistently for a number of years, choose assets wisely, diversify your holdings, and regularly add to the account, it is possible to amass a large balance by the time retirement comes along.