IDEASMILLIONDOLLAR

By Kevin Salveson

 

 

Everyone needs sound money management.   Beyond physical health, financial health is a primary concern for everyone.  Planning for the future, structuring and managing your estate, building your net worth in pursuit of a comfortable retirement and a legacy for your family ...these are some of the most important goals in life.  Of course, there are endless questions a smart investor will ask.

 

What investments should I make? What happens when risk appears to rise?  When should I make a move? What move do I make?

 

I believe these questions are answered more easily than one might think.  Having helped many clients in my former position as a Financial Advisor, I think much of it can be boiled down to two simple ideas.

 

The first idea is: find someone with expertise whom you trust and enjoy working with at a reasonable cost to do most of the work.  The second idea is what Warren Buffett calls Investing Rule #1: “Don't lose money”. And the second rule is "Don’t forget rule #1".

 

 

COMPOUNDING

 

Both the idea of the trusted, low-cost advisor and of avoiding losses when possible are intertwined in that they both are a function of one of the most basic concepts in investing, Compounding.  This is what anyone should do. Mitigate losses and manage risk, compound your gains, spend wisely, and save systematically.

 

I believe that's all it really takes.  And not losing, or taking excessive risk, is part of that.  That goes opposite what many advisors say.  "You have to be in it to win it," etc, they will tell you.  (Later, in another installment, I will present evidence that it is better to avoid big loss days rather than stick with them to capture the big up days in the market, which is the opposite of what the finance world generally tells the average investor).  The fact is, you also have to be in it to be able to lose it.  But what if you weren't in it at all, and couldn't lose it.  Well, they say, you will miss the gains.  Sure, you will miss the volatile returns of the stock market.  But that doesn't mean you've chosen to not get gains at all.  You simply may have chosen to get gains at lower risk.  Basically, instead of risk-taking in their 401ks or stockpicking,  I believe that people should only invest what they can stand to lose and put the rest someplace where it can compound. This is because the result of waiting or losing money early can be devastating.  

 

 

A TALE OF TWO INVESTORS 

 

Take a look at the following after-tax example of Two Investors where the difference is that one does not choose to compound early on as the other.  Their divergent long term results may surprise you.  (Please note that these examples are for illustrative purposes and aren’t intended to represent any specific return, yield, or investment, nor is it indicative of future results.)

 

INVESTOR #1: 

Begins with a balance of $100,000, earns a compound rate of 1% APY for 1 year, then earns a compound rate of 6% APY for 29 years.   Result: $$542,381

 

INVESTOR#2: Begins with a balance of $100,000, earns a compound rate of 6% APY for all 30 years.   Result: $574,349

 

Time Difference:

 One year at 1% instead of 6% for Investor #1.

 

Well, that's not much of a difference, just one little percent in the very first year only.  But the Dollar Difference is huge.  At the end of the Investment Period investor #2 made $31,968 more.

 

You can check the math yoursef.  As you can see, the difference of a measley 1% in the first year can add up.  This is all due to the nature of compounding.  Time is your ally as long as you don't lose money and put yourself in the hole it will take a long time just to climb out of.  

 

Don't.  Lose.  Money.  That is Rule #1.

 

 

--Kevin Salveson

 

(Note: We will have more on compounding in future installments of this blog.)