The effects of compounding returns over time can be extremely powerful.
The period of time over which a typical person builds the bulk of their financial assets is 20 - 40 years: from when they start working and investing to when they start to deplete their portfolio in retirement.
Have you ever wondered how large family fortunes are built - the kind of 'old' money that is passed from one generation to the next? Or how elite universities and other institutions like the Church have built their massive endowments? The answer can be summed up in one word - time! If you can invest money over multigenerational periods of time the results can be truly staggering.
Let's take a look at a fun example.
Imagine that you invest $10,000 today in a well-diversified stock portfolio and that you leave instructions in your will that this money is for the sole use of your greatgrandchildren when they reach the age of 25.
It is unlikely that you will live to see that day, but if you did you would be in for quite a surprise.
First let's throw in a few assumptions.
First, we'll assume that this investment earns an annualized 8% over the life of the investment.
And we'll also assume that annualized inflation over this period will be 3%.
Of course the future may well turn out to be quite different.
We could run some sophisticated simulations to find out what would happen under various possible scenarios based on historical data.
But this is just for fun, so I am going to stick with my simple assumptions for the purpose of illustration.
The spirit of the results is what matters here! We'll also ignore the effects of taxes and transaction costs, both of which could actually be effectively minimized in various ways.
Lastly we will assume that you are 30 years old today and have just given birth to your first child.
Congratulations! We'll also assume that your next 2 generations will also have their first kids at 30.
So your $10,000 is going to be locked up for 85 years.
On your great-grandchild's 25th birthday he or she will inherit the whopping sum of $6.
9 million! Hang on a second, I hear you say.
A dollar in 85 years' time is going to buy a lot less than a dollar buys today.
That is absolutely correct.
So let's adjust for the effects of inflation - which we simplistically assumed to be 3% per year.
It still turns out that your lucky descendent will inherit a portfolio worth over $562,000 in today's dollars.
Not bad at all!
The period of time over which a typical person builds the bulk of their financial assets is 20 - 40 years: from when they start working and investing to when they start to deplete their portfolio in retirement.
Have you ever wondered how large family fortunes are built - the kind of 'old' money that is passed from one generation to the next? Or how elite universities and other institutions like the Church have built their massive endowments? The answer can be summed up in one word - time! If you can invest money over multigenerational periods of time the results can be truly staggering.
Let's take a look at a fun example.
Imagine that you invest $10,000 today in a well-diversified stock portfolio and that you leave instructions in your will that this money is for the sole use of your greatgrandchildren when they reach the age of 25.
It is unlikely that you will live to see that day, but if you did you would be in for quite a surprise.
First let's throw in a few assumptions.
First, we'll assume that this investment earns an annualized 8% over the life of the investment.
And we'll also assume that annualized inflation over this period will be 3%.
Of course the future may well turn out to be quite different.
We could run some sophisticated simulations to find out what would happen under various possible scenarios based on historical data.
But this is just for fun, so I am going to stick with my simple assumptions for the purpose of illustration.
The spirit of the results is what matters here! We'll also ignore the effects of taxes and transaction costs, both of which could actually be effectively minimized in various ways.
Lastly we will assume that you are 30 years old today and have just given birth to your first child.
Congratulations! We'll also assume that your next 2 generations will also have their first kids at 30.
So your $10,000 is going to be locked up for 85 years.
On your great-grandchild's 25th birthday he or she will inherit the whopping sum of $6.
9 million! Hang on a second, I hear you say.
A dollar in 85 years' time is going to buy a lot less than a dollar buys today.
That is absolutely correct.
So let's adjust for the effects of inflation - which we simplistically assumed to be 3% per year.
It still turns out that your lucky descendent will inherit a portfolio worth over $562,000 in today's dollars.
Not bad at all!
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