Saver's Digest (Click Here to Download PDF)

Compounding: The Eighth Wonder of the World

"Compounding of interest is the greatest mathematical discovery of all time." -- Albert Einstein.

Would you rather have a million dollars or a penny that doubled in value every day? The wise choice would be to take the penny, because after thirty days, it would be worth over ten million dollars!

How could that be? It's the spectacular results of 100 percent earnings compounded daily! In real life, compounded earnings are more modest, but the outcome is still pretty amazing.

Similar to what happens when you save using your employer's retirement savings plan, you earn a return not only on the money you contribute, but also on the earnings your contributions generate. So, the more money you save and the earlier you save it, the more quickly compounded earnings can accumulate.

The results of making regular contributions to your plan, combined with compounded earnings, can be impressive. See how much a monthly contribution of just $50 a month could grow over time.
Past performance is not a guarantee of future results. Actual returns on a 50/50 mix of bonds and stocks will vary from year to year. Even if the actual long-term average rate of return equals 8%, both the variations in returns from year to year and the sequence of those annual returns can have a significant effect on the amount accumulated.

Branch Out: Diversify

Earning a higher consistent rate of return year to year on growth investments (stocks) is tough. As both a saver and investor, you may have competing goals and expect a certain level of growth, but also want stability.

Is it possible to satisfy both requirements? What we need is a way to reduce the risk of using volatile, growth investments and still have peace of mind. This is where diversification becomes important.

By diversifying, you spread your risk around, so a poorly performing investment can't do too much damage to your total invested savings. You can diversify on many levels. The most important level is across asset classes - stable value, bond and stock investments. After this level - consider spreading your investments into different types within classes. You can diversify among stocks based on company size (small cap vs. large cap), investment style (value vs. growth) and by country (U.S. vs. foreign stocks). You can diversify among bonds based on the term of the bond (such as short, intermediate or long), and issuer type (such as Treasuries, TIPS, high-quality corporate, and high-yield corporate). Individual mutual fund managers also diversify their holdings between many companies, industries, and countries.

How does all this work? Each investment category has its own unique return pattern, which is somewhat independent of happenings in other asset categories. Stable investments act as anchors, while stock investments provide differing return patterns: sometimes high, sometimes low.

When you diversify, a loss in one fund may be offset by a gain in another. The investments offered in your retirement savings plan perform differently at any given time. Diversifying your investments can help smooth out year-to-year returns and reduce your overall risk.

Looking for higher returns with reduced risks? Check your diversification!

Get into the Savings Habit

How do you meet your financial goals - maybe a dream house, education for your children, retirement? By saving. The more you put away each month, the more quickly you will reach your goals. So how, with today's bills, everyday expenses, and other needs, can you manage to put enough money aside for things down the road? Here are some tips that will help you find those extra dollars each month - after all, every penny counts!

Reduce debt. This is the first rule of saving money. Paying interest on your credit cards cancels out interest you are earning on your savings. So, find a way to pay off those credit cards as quickly as possible. Then, make sure you don't spend more than you can afford to pay off at the end of each month. That way you can avoid interest charges altogether.

Pay yourself first. People tend to spend money according to the "what's in my pocket" budget. When less money is available, you force yourself to budget accordingly. Take advantage of automatic paycheck deductions, putting aside money before you receive your paycheck. Give yourself a set allowance each week for incidental spending. Carry a certain amount of cash and leave your debit and credit cards at home. Setting limits will help you avoid overspending.

Visualize your savings goals. It is easier to make saving a priority when your goals are meaningful to you, rather than distant ideas. A clear picture of the retirement travels you are looking forward to will have a much better chance of competing against that fancy dinner out than the vague notion that you should be saving some of your paycheck.

Be aware of how much you spend. Try writing down everything you spend money on for one month. Chances are, you'll be able to find places where you can easily cut back with minimal or no change to your lifestyle. Saving a few dollars a month that you may not miss anyway can make a huge difference in the long run. So, do your research and figure out where those dollars are going!

Finally, commit to your savings plan. No matter how much money you decide to put away each month, be consistent and faithful. Keep your savings separate from your spending money and avoid dipping into it. Remember that every dollar represents your hard work - make it count!

General Guidelines for Generational Saving

Are you a baby boomer? Generation X or Y? Find out below how to tell which generation you fall into and how much you should be saving to reach your retirement goals.

Traditionalists 1900-1945 Loyal WW I&II, Pearl Harbor, Hiroshima, The Great Depression, The New Deal Franklin Roosevelt, Betty Crocker, Joe DiMaggio, Dr. Spock You are likely retired or almost retired. This is probably a good time to consider distribution options. You may want to talk to a financial planner about designing a strategy for generating retirement income.

Baby Boomers 1946-1964 Optimistic Vietnam, Kent State, Watergate, first man on the moon, Woodstock Martin Luther King, Jr., John F. Kennedy, Rosa Parks, Barbra Streisand, Jimi Hendrix If you are not already retired, you are getting close. You should be saving as much as possible, around 12-15% of your income. Remember that those aged 50 and older are allowed a $5,500 catch-up contribution each year.

Generation X 1965-1979 Skeptical Space shuttle explosion, fall of the Berlin Wall, Gulf War, technology boom Bill Gates, Monica Lewinsky, Quentin Tarantino, O.J. Simpson, Madonna, Michael Jordan If you are just getting started saving, you will likely need to save 7-10% of your income to reach your retirement goals. If you have already started, 5-7% may be enough.

Generation Y (also called New Boomers, Generation "Why," or Millennials) 1980-2000 Realistic Clinton impeachment, Columbine, 9/11, Oklahoma City, Iraq War, internet Prince William, George W. Bush, Kurt Cobain, Britney Spears, Barney You are likely just getting started and have the advantage of time. By starting early, saving 3-5% of your income may be enough to reach your retirement goals.
No matter what your generation, take the time to calculate your retirement savings goal to make sure you're on track for a secure retirement!

Sources: When Generations Collide by Lynne Lancaster and David Stillman; Harper Paperbacks, © 2003; "Understanding Generations" by Jane Jopling; West Virginia University Extension Service, 2004
The information in this publication is not tax or financial advice. You are encouraged to review the provisions of your plan and to consult a financial or tax advisor on these and other tax and financial planning matters.

© 2009 Arnerich Massena Education, Inc. Articles reprinted by permission.