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9 reasons why saving $1 a day builds fortunes

Reprinted courtesy of MarketWatch.com.

To read the original article click here

Some MarketWatch readers think I’m an idiot.

When I wrote a few weeks ago that a very-long-term investment had a reasonable chance to grow at 12%, some of the comments pulled no punches.

A few samples:

  • This was the worst article ever written.
  • 12% per year? HAHAHAHA!!! Wow man, get a life.
  • What a joke … and he wants us to believe in the tooth fairy too.

Notice to readers: Being called an idiot isn’t new to me. About 14 years ago I was regarded as equally “idiotic” when I suggested that a long-term return of 12% was a worthwhile goal. The buzz at that time was that anybody who couldn’t get 15% to 18% a year was stupid.

In this recent article, I described how parents or grandparents could make a child rich (eventually) by investing only $1 a day. I suggested investing in the asset class of small-cap value stocks.

Is 12% reasonable? As I reported in that article, the Standard & Poor’s 500 IndexSPX, -0.01%  compounded at 10% for the past 88 years. The longest track record we have for small-cap value stocks goes back to 1928; since then, this asset class has grown at 13.8%.

You can be the judge. But it appears that some readers’ hair-trigger responses were the result of looking only at recent history. Interestingly, that’s exactly the same mistake that some readers made 14 years ago when all they could see were recent hot returns of U.S. growth stocks.

Some important lessons in my recent $1-a-day article may have been overlooked. Here are nine of them:

1. Compound interest, given enough time, is an amazingly effective tool. Albert Einstein once described compound interest as the greatest invention of mankind. Smart investors put Einstein’s insight to work for themselves.

It’s largely thanks to compound interest that a mere $1 a day saved from the day a child is born until she’s 18 can grow into about $4 million by the time she’s ready to retire at 66.

2. The impact of starting early is greater than most people expect. When you’re saving for retirement, every dollar saved at birth becomes worth much, much more than a dollar saved at age 20. And a dollar saved at 20 is more valuable than even $2 saved at age 30.

Here are the numbers, assuming a single investment of only $1.00, compound returns of 10% annually and a payoff on an investor’s 66th birthday:

  • $1 saved at birth grows to $539.41;
  • $1 saved at age 20 grows to $80.18;
  • $2 saved at age 30 grows to $61.83.

3. When it comes to compounded investment returns, little things mean a whole lot. Returning to those three same scenarios, we find that if the compound rate were 12% instead of 10%, the results would be:

  • $1 saved at birth grows to $1,771.70 (more than three times as much);
  • $1 saved at age 20 grows to $183.67 (more than twice as much);
  • $2 saved at age 30 grows to $118.27 (nearly twice as much).

4. Certainly many things can go wrong in the lifetime of an investor, and no plan (no matter how brilliant on paper) is guaranteed to succeed. The forces of inflation, deflation, economic collapses, political unrest, global warming and health can derail any individual’s planning.

But the point of the $1 a day exercise is to start small and especially to start early. Regardless of all that could go astray, I think anybody would rather have $4 million at retirement age than nothing except Social Security.

5. If you want to achieve any remarkable success, there is simply no substitute for long-term thinking and long-term planning. In the hypothetical examples in that article, it was no accident that a very modest initial investment (18 annual contributions of $365) eventually became $4 million.

Doing this required the entire life of a child who turned into a woman (and presumably later into a mother and grandmother) whose life was dramatically changed because of the foresight of her parents.

6. When somebody accomplishes such an amazing feat, other people are likely to learn of it, and some of them will be inspired to change other people’s lives.

Young people tend to learn the most about money from the examples set by their parents. Parents (and grandparents, too) can make an enormous difference in a young person’s outlook by combining a very long view, generosity and long-term optimism.

This in itself is a great gift. And if it works out, there’s the possibility of setting a precedent or family tradition for future generations. I have seen such things happen from what seem like small beginnings.

7. Warren Buffett once said: “You only have to do a very few things right in your life so long as you don’t do too many things wrong.”

Turning a few thousand dollars into an eventual $4 million is an excellent example. Only a few things were required: A long-term vision, some initial financial gifts, a relatively simple investment plan and tons of patience.

None of these things relied on good fortune. Instead, they grew out of good sense.

8. This point should be obvious, but apparently a lot of people don’t believe it: You don’t have to have a lot of money to get started. Time is the secret ingredient. Invested early enough, small amounts of money can produce life-changing results.

Far too many young people (and unfortunately some who are old enough to be their parents) take the position that they will start saving seriously when they have enough money to make some “big money.”

They are wrong. Starting small is how the race gets won.

9. Most times, “If it sounds too good to be true, it is” is an accurate statement. But sometimes what seems incredibly good is actually what it’s cracked up to be.

Try this out: Successful investing can be quite simple. The $1-a-day example demonstrates this.

I have friends who know how to sail, and they’ve told me that learning is simple and complex all at once. Here’s the simple: In a day, with a good teacher, a good wind and a good boat, you can learn all the basics you’ll need for a lifetime of sailing pleasure.

Here’s the complex: Avid sailors can happily spend the rest of their lives perfecting their techniques and their equipment. I think investing is like that. You can learn the basics pretty easily, and you can spend a lifetime, if you want to, getting every last detail just right.

Fortunately, both approaches work fine. Anyone who is willing to commit some time and some money along with the right habits and attitudes can wind up a winner.

Richard Buck contributed to this article.