Who hasn’t heard or joked about some present that keeps on giving? A little fun fact, the popular phrase the “gift that keeps on giving” was originally associated with Victor Radio’s in the 1920s, later RCA TVs, and many others have used variations of it over time. It is now a popular parody phrase too.
What really is a gift that can keep on giving? This of course depends on what you value and care about. Then, is it even possible for something to keep giving? When it comes to money – something that is useful and valued by most people – there really is something that has historically helped grow people’s money over time.
Compounding Could Really Be Your Magical Gift
In the financial world, there is this fantastic thing called compounding. When you put money into stocks, bonds, or cash, they earn dividends and/or interest, and investments like stocks and bonds can also achieve price or market growth too. Over time your money can grow in an exciting way. This is called compounding, or compounded returns.
Consider this, a $1,000 invested one-time over 40-years that achieves a return of 8% each year will turn into over $20,000.* That’s right, over $19,000 of the greater than $20,000 dollars in savings is generated from compounding!
Your 401(k) Can Make It Easier to Build the Giving Gift
Now think about if you put a steady amount or percent of your salary each paycheck into your 401(k) for 30 or 40 years. How much might this build to?
While there are no guarantees, historically speaking, you’re likely be more than a millionaire.* Yes, a person earning $50,000 per year every year for 40-years that puts in 7% of salary (puts in $3,600 each year for 40 years), will be a millionaire assuming an 8% return each year.
So how does it make it easier? Your 401(k) does three main things to help:
- Pulls from your salary automatically to put saving on autopilot. Many people struggle to save regularly unless it is done automatically and put in a place not easily accessible. 401(k)s do just that.
- Your money grows without taxes on dividends or interest in your 401(k) plan. So, there is no tax drag over the years it stays invested in your 401(k) to help your money build. You will be taxed on the money you withdraw in retirement at your tax rate at that future time.
- Often employers provide a match so that when you contribute to your 401(k), your employer will add to your retirement savings too. That’s free money! Let’s say your employer matches 3% if you put in 6% of salary. If you put in 6%, just like that you are contributing 9% for your future self.
Einstein is credited with saying, "The most powerful force in the universe is compound interest." Whether he said it not, when it comes to our financial lives, it rings true. Happy saving.
*Examples cited are hypothetical and compare how a one-time investment of $1,000 or investing $3,600 each year for 40 years can grow over time assuming an 8.0% fixed annual rate of return. Your account may earn more or less. This is a hypothetical example only, and not a guarantee of future returns. Actual experience will vary with portfolio selections and changing market conditions. The total account balance does not take into account federal and state income taxes, which will be due upon withdrawal. Assets withdrawn before 59½ may incur a 10% tax penalty.
Side Note on Investment Returns
In the compounding example, we illustrate the impact of 8% annual returns over 40 years. Is 8% annual returns really doable? We don’t know. We do know that between 1926-2018 that a portfolio built with 60% stock funds and 40% bonds delivered 8.27% annually during this period (50% invested in large company stocks, 10% small company stocks, 35% long-term government bonds, and 5% U.S. Treasuries). During this time period, small stocks delivered 11.8% annually, large stocks 10%, LT Gov Bonds 5.5% and U.S. Treasuries 3.3%. These past returns of course do not guarantee how these asset classes will perform in the future. Each year and time period will be different so you can expect your portfolio to deliver a different percentage over time based on how you invest, how long you invest, and market fluctuations.