Step 1. Set Goals (and Reach Them)
Success to me is having ten honeydew melons, and eating only the top half of each one.
-- Barbra Streisand
What does success mean to you? If you're like many teens, success might be excelling at school or in athletics, getting into and thriving at the college of your choice, preparing for a career you'll love, finding the perfect boyfriend or girlfriend, or just not making a complete idiot of yourself in public!
Since this is a financial book, think for a moment about what success means to you financially. Hey, we know that up till now, you might not have given it a moment's thought. So humor us. You might start by thinking, Success is...well...hey, I just want to be rich! So let's start there. How would you define "rich"? Today, 40 percent of the world's population, more than two billion people, struggle to live on less than $2 per day. Viewed from that perspective, you're already stinking rich. In that context, virtually all Americans are.
We asked a bunch of teens to define "rich," and the answers varied widely. Some thought that if you made $250,000 per year, you were rich. Others thought having $2 million or $5 million stashed in an account would do it. One explained that if you had enough money in the bank to live comfortably just off the interest (payments a bank makes to you for keeping your savings with them), without working, then you were rich. The common thread running through most of the responses was that you're rich if you're able to buy what you want, within reason.
What's "reasonable"? It's probably not reasonable to anticipate owning mansions in three different countries, driving a Porsche with a Bentley in the garage, and having a large staff (masseuse, fan waver, grape feeder, foot rubber, and palm reader) tending to your every wish. You may not even want any of that stuff. It is reasonable, though, to aspire to someday own a house you love, one or two cars for your family, and enough of the things that give you pleasure that you call yourself content with life. Stuff like musical instruments, pets, maybe a boat, a home entertainment center, a fast computer, a decent wardrobe (um, less than fifty pairs of shoes, please), workout equipment, shelves full of books...and an android (gotta have an android).
Take a few minutes now to list some of your goals and dreams, both long- and short-term. You might think this a silly exercise. But ain't it peculiar how few people spend time thinking out and writing down their dreams? Dream a little. What do you want to be, to do, to call your own? Then estimate how much you think each one would cost (some will be easier to guess at than others -- and some will have no associated financial cost).
I want to be: Estimated Cost:
I want to do:
I want to own:
We've got some good news for you. And then some even better news. Chances are you can meet a bunch of your goals even if you don't read our book. Just be ambitious for them -- whether it's hiking the Himalayas or starting your own bookstore or writing for The Simpsons.
All of that said, if you do learn the basics of your money with us, you'll likely reach more of them -- perhaps even all of them. Without robbing any banks, without saving and overpolishing every penny you ever get your hands on, without sacrificing joy, you can finance the dreams that need financing. If you get started now.
Time for a relevant tale.
In 1932, Anne Scheiber was a thirty-eight-year-old auditor for the Internal Revenue Service. Attracted by the promise of the stock market, she forked over most of her life savings to her brother, a young stockbroker on Wall Street. Disastrously, his entire brokerage firm went bankrupt, and Anne lost all her investments. (Moral of the story -- and you'll find us nodding our heads at this one: Keep a darn close eye on your brother.)
Determined to try again and do it on her own, she then saved $5,000 and plunked it back into stocks in 1944. By the time she died in 1995 (at the age of 101) -- get this -- her money had grown to $22 million -- far more than any of us need in this life.
How'd she do it?
Well, to start, she was a long-term, involved investor. She wasn't trying to strike it rich overnight. She didn't buy stock today and then sell it tomorrow (something that too many people try, with little success). She attended shareholder meetings and followed her companies closely. She bought big, name-brand companies like Pepsi, Chrysler, and Coca-Cola. She reinvested the money that companies sent her as "dividends," buying more shares of stock with it. And she placed her faith -- and her money -- in these growing companies and patiently watched their earnings expand over decades.
Some years, Anne's companies struggled. Other years, the stock market got hammered. In 1973 and 1974, the market lost nearly half its value. It was a very discouraging time. President Nixon left the White House in disgrace. United States Armed Forces left Vietnam in defeat. The nation's over-reliance on oil from the Middle East sent our economy into a tailspin. And everyone thought the new bell-bottom pants were really cool. We had just about hit rock bottom. But Anne Scheiber held on to her investments. She was rewarded for doing so. When she died, she donated her $20 million plus to Yeshiva University in New York.
How the heck did she do it?
Anne invested relatively little money in the middle of her life, then watched it grow to an enormous sum. You may be thinking, Yeah, but that was decades ago; things are different now. Not so fast! Although a lot has changed since 1944, the stock market is still around, still making people like you wealthy. We'll explain how in subsequent chapters.
Or you might think, Geez, I don't want to wait fifty years to become a millionaire! And that's a fair point. Note, though, that she ended up with more than $20 million. If you're happy with just $5 million, you won't need fifty years. Also, she started with just $5,000 and added very little after that. You can put more than that away in the years ahead, if you're motivated. Start saving and ask your extended family to match every dollar you save. We'll show you how. You'll be there in no time.
If you get started, we think you can have whatever money you'll need to finance your dreams. If you get started now, you'll win, just as Anne Scheiber did. Errr...well, mostly. Because you might not want to do it just the way she did. Why not? According to those who knew her, Anne kept to herself, lived alone in a small New York City apartment, wore the same coat day after day, year after year, and often skipped meals rather than use her money.
So that part's actually quite sad -- sad because it obviously wasn't necessary.
Check this out again: She was worth millions of dollars, but she skipped meals, wore old clothes, and basically had no friends. We're going out on a limb here and speculating that she didn't ever pick up her Motley Fool teen guide and fill out what you just did -- your list of dreams in life. What's clear is that she settled for the sole pursuit of money, rather than the pursuit of money to enhance her life and the world around her. There's a big difference between the two -- a difference that makes all the difference.
Fortunately, you don't need to pinch every penny to succeed in saving and investing. And you have filled out your list of dreams above (if not, go back and complete the task!). We Fools generally love investing and creating wealth alongside the many other pleasures that life has to offer. Stuff like reading books, whipping a Frisbee around an open field, tossing a dart at a world map and traveling there this summer with our two best friends, sleeping late on Sunday, going to movie festivals, swimming the English Channel, or just sitting around making jokes about Dad wearing black socks and tennis shoes. Ya know, the regular stuff.
Anne Scheiber's investment legacy provides a powerful example of what you can achieve if you're methodical and patient with money. She also reminds us, though, to stop, plant, water, tend to, and smell the roses now and then. Both matter.
If you're not the type who enjoys math class, that's okay. If you don't delight in figuring out how long it'll take that plane to get from Phoenix to Denver, no problem. If you don't put on big sloppy grins at quadratic equations, breathe easy. We're going to do a little math together that all of us can enjoy.
It's time to talk about the magic of compounding growth. This mathematical force applied to your money depends on three key factors:
1. How much money you invest.
2. How long you set aside your money.
3. How much your invested money grows each year.
Let's look at some examples. We'll start with a simple one.
We'll start with $100. Your $100. The hundred bucks you set aside after mowing half a dozen lawns or changing a bunch of diapers or just cracking open the birthday check from your grandparents (you lucky dawg). Let's take that $100, invest it in the stock market, and see what happens. It'll earn the market's average yearly gain of 10 percent. Look there, you're already making money. After the first year, your $100 grows to $110. You made ten bucks. After the second year, the $110 grows to $121. Look at that. You made $11. Then after year three, your money grows to $133. Even though it climbed the same 10 percent, you made $12.
Interesting. But kinda boring, right?
Well, now let's watch it over longer periods of time.
Growing $100 over Time
Start with $100. Grow it by 10 percent per year. And here's what happens:
Year Total Add 10%
1 $100 $10
2 $110 $11
3 $121 $12
4 $133 $13
5 $146 $15
10 $236 $24
50 $10,672 $1,067
100 $1.25 million $125,278
300 $238 trillion $23.8 trillion
Do you see what's happening? It's like watching water trickle, then roll, then storm over a dam. The more water pressure and the more time, the greater the flood. Your initial bundle of $100 is growing, and the dollar amount by which it's growing is also growing. That's compounding. It's a flood. It's the flood responsible for creating the majority of wealth in America today.
Another way to think about this is that the $10 you added kept growing by 10 percent per year, and so did the $11 you added next, and the $12, and so on. It all kept piling up and growing. In just eight years, you double your money. Which isn't that inspiring with just $100. But after fifty years, your measly hundred bucks is worth more than $10,000. And after three centuries of steady growth, your small investment is worth $240 trillion -- enough for your ancestors to own a few planets (and put them all in your name) in the year 2400. And if these numbers don't inspire you, imagine what happens when you save and invest $100 each year, or $1,000 each year, or more. This is how enduring wealth is created.
Growing $100 at a Time
In our example above, we had you set aside just $100 and grow that 10 percent every year thereafter. Now let's look at noncompounding, or linear, growth. In this example, as in the first example, you're setting aside $100 today. But in this one you just add another $100 in savings to your initial sum every year thereafter, but with no annual growth of those savings. No investment, just savings.
As you can see below, you're pretty psyched as you enter year two, when your money doubles to $200 (because you added $100 of savings to it). Remember, you had to wait eight full years for your $100 investment above to double. Congratulations, your savings just doubled your hundred bucks in a single year. Upon the conclusion of year two, you then jumped to $300. Blowout, right? But look what happens after that, and compare to the table from the first example:
Wow, what a difference. In our compounding example -- where the growth was in percentage, not total, terms -- you have more than $1 million after you tortoised your way through a hundred years. In our linear example, even though your hare got a great start out of the gates, you have just $10,000 to show for your efforts a hundred years later. Truly hare-y. (That will be the only bad pun in this book...we promise.) (Except for the others.)
Compare them against each other.
Year Linear Savings Growth Geometric Investment Growth
1 $100 $100
2 $200 $110
3 $300 $121
4 $400 $133
5 $500 $146
10 $1,000 $236
50 $5,000 $10,672
100 $10,000 $1.25 million
300 $30,000 $238 trillion
To create wealth and live without financial worry, you absolutely must participate in the compounding growth of the bond and stock market. And the sooner the better. Which is why we keep shouting, "Great news for you!" throughout this book. The more years you have, the better the news gets. When you put the linear growth of savings into the geometric growth of investment, you have both columns above working in your favor. In this book, we'll show you how to achieve both.
Now that you're getting the hang of things, let's dig just a little bit deeper together. The growth rate -- how fast your money grows, on average, from year to year -- is very important. Let's start over, using $100 again. This time we'll compound its growth at three other yearly rates: 5 percent, 11 percent, and 13 percent. Five percent is what you might earn in interest in a money-market account (a long-term savings account at a bank). Eleven percent is the historical average growth rate of the stock market for most of the last century. Thirteen percent is how fast your money might grow if you wound up being an interested, self-motivated, and successful stock picker. The first two rates, 5 and 11 percent, you can earn with virtually no effort. We'll show you how in the chapters ahead. Thirteen percent, though, will demand extra work on your part. More on that later.
Compounding at Different Rates of Growth
If you start with $100 and it grows at 5 percent, 11 percent, and 13 percent, here's how much you'll have after the following periods of time.
Year 5% 11% 13%
10 $163 $284 $405
20 $265 $806 $1,152
30 $432 $2,289 $3,912
40 $704 $6,500 $13,278
50 $1,147 $18,456 $45,074
And that's just a lousy $100 set aside today. That doesn't include any additional savings you might have in the years to come -- savings that will very significantly improve your results.
Consider three lessons from the numbers above.
1. Wow, look what happens to money over time. The measly $100 getting 11 percent yearly growth turns into more than $18,000 in fifty years.
2. The different growth rates really affect the results. Getting the stock market's average return of 11 percent makes a huge difference over that 5 percent return (comparable to putting your money in a bank account).
3. Yes, we know we've presented very long time horizons. But you're a teenager. You have years and decades ahead of you. Can you really not stick $100 aside for fifty years and just see what happens? How about $1,000? What if you could put away $10,000 for fifty years and get the stock market's average return? The answer is, you'd have more than $1.8 million. Let's meet up on the beaches of New Zealand a few decades from now, eh?
Keep in mind that not all growth rates are the same. If your bank is paying you 3 percent interest on your savings, that's pretty much guaranteed. If a savings bond is paying you 5 percent interest, that's also darn close to a sure thing.
The stock market, however, particularly over short-term periods, is anything but a sure thing. Same goes for bonds (we'll explain bonds in the chapters ahead -- they represent loans that you make and draw interest from). The "returns" (what you make) of these investment classes can fluctuate dramatically from one year to the next. There are good years, great years, so-so years, and years we'd much rather forget (like 2000 and 2001). Over long periods of time, though, the stock market has averaged an annual 11 percent return.
Similarly, many individual companies remain strong for a decade or more, some even for a century. Others fail -- sometimes quite quickly. In fact, the great majority of new start-up businesses fail within the first five years. If you focus on investing in truly solid, growing companies, on average you'll be much more likely to earn something like that annual 13 percent we mentioned above. If you select one or more companies that turn out to be remarkable growers, such as Microsoft, the average growth rate for your investments might be higher than 13 percent. We'll spend the latter pages of this book helping you find some of these wonderful companies.
You should now have a sense of how money can grow over time and how much growth rates matter. Now let's turbocharge our results. Let's increase your up-front savings. Instead of starting with an initial investment of just $100, let's see what happens with $1,000. A thousand bucks shouldn't seem like an unthinkable sum of money. That's just savings of $20 a week for an entire year. And saving $20 per week isn't as tough as you might think. In fact, in the next chapter, we'll help you do just that. For now, let's see what happens to your $1,000 in savings.
Growing $1,000 over Time
If you start with $1,000 and it grows at 5 percent, 11 percent, and 13 percent, here's how much you'll have after various periods of time.
Year 5% 11% 13%
10 $1,629 $2,839 $3,395
20 $2,653 $8,062 $11,523
30 $4,322 $22,892 $39,116
40 $7,040 $65,001 $132,782
50 $11,467 $184,565 $450,736
Notice that the numbers in the table for $1,000 are simply ten times greater than those in the $100 table. When it comes to your money, the most important math is pretty easy. But it's crucially important. The teenagers around you who'll be surfing off Oahu, taking a year off from work, or retiring early when they're forty-seven are in so many cases the teenagers who learn to save and invest today.
How Compounding Can Work in Your Lifetime
Let's add a little twist here. Opposite are two tables you've already looked at, with spaces for you to insert your age. This will help you see how this compounding scenario might apply to your life.
How $100 Can Grow in Your Lifetime
Enter your current age in Year 0. Then calculate and enter your age after ten, twenty, thirty, forty, and fifty years.
Year Your age 5% 11% 13%
10 ______ $163 $284 $405
20 ______ $265 $806 $1,152
30 ______ $432 $2,289 $3,912
40 ______ $704 $6,500 $13,278
50 ______ $1,147 $18,456 $45,074
How $1,000 Can Grow in Your Lifetime
Let's try this again with $1,000 up front.
Year Your age 5% 11% 15%
10 ___________ $1,629 $2,839 $3,395
20 ___________ $2,653 $8,062 $11,523
30 ___________ $4,322 $22,892 $39,116
40 ___________ $7,040 $65,001 $132,782
50 ___________ $11,467 $184,565 $450,736
Pretty remarkable what happens if you put some money away, invest it, and patiently let it grow over time. You can secure your retirement. Invest $1,000 a year, get the stock market's returns for fifty years, then cash out with a fortune. What's the challenge? Getting started early.
Is all this math stressing you out? We're almost done. This is extremely important stuff -- stuff that could dramatically improve the life you live. So don't think of it as math -- think about what the tables represent! They show you how small sums of your money can grow into large sums. You start with enough money to buy a CD player and end with enough to buy a car or house. All the while, you're not actually doing any intense labor to make it grow.
Let's tweak these tables one last way, to make them more realistic. After all, how likely is it that you'd invest just $100 or $1,000 in one shot when you're a teen and then add nothing else? Here's what happens when you invest money regularly.
Investing $100 Each Year
If you start with an initial investment of $100 and add $100 every year, and your little bundle of wealth grows at 11 percent per year, here's how much you'll have in the years ahead.
Again, that's just $100 per year. C'mon. That's chicken feed!
Compare this table with the one showing you how a single $100 grows over time at 11 percent, and you'll see some interesting things. A number that pops out at us is $6,500. That's how much you'll have after forty years, if you just invest one $100 bill. But as you've just seen, if you're plunking down $100 each year, you'll reach $6,500 in just twenty years -- half as long. That's the power of both saving and investing.
Now, we know twenty years probably sounds like a reaaaaaal long time. But what we're trying to teach here is the extraordinary benefit of setting aside a little of your money now for long periods of time. Your money will double, then double again, then double that doubled double. And if you're patient with those small sums, you'll find yourself with enough money to enjoy the opportunities of life. If that sounds silly, keep reading, young Fool. Mayhaps what sound like just notes will turn into song in the pages ahead.
You're probably a fan of the power of compounding already, but we'll give it one more shot. Imagine two people of the same age. Let's call them Marge and Homer.
Marge begins investing at age fifteen. Via bake sales and newspaper routes and household chores for her parents, she manages to save and invest $1,000 in the stock market each year. She stops doing so at age thirty, having invested a total of $15,000. After this, she never invests again. Never. Not for the rest of her life. On the money she's already invested, she gets the market's historical average return of 11 percent.
Homer, meanwhile, is a late bloomer. He doesn't get his financial wake-up call until he's thirty-five. Unfortunately, that's not unusual. Beginning at age thirty-five, Homer then scrapes together not $1,000, but $5,000 each year and invests it. Let's hear it for Homer. He keeps at this, putting away $5,000 each year, until retiring at age sixty-five. That amounts to a total of thirty years, and $150,000 invested. And Homer also gets the average rate of return of the stock market, 11 percent growth per year.
Homer has invested ten times more than Marge. But he started twenty years later.
Who ends up winning this race?
Here are the numbers:
Begins investing at age: 15 35
Stops adding money at age: 30 65
Invests each year: $1,000 $5,000
Invests a total of: $15,000 $150,000
Total grows each year by: 11% 11%
Total worth at age 65: $1,473,172 $1,104,566
Hard to believe, ain't it?
The big lesson here is time. It's the critical advantage that you, as a teenager, have over every adult -- including the authors of this book. In fact, since we, the authors of this book, are in our thirties, we are like Homer to your Marge. Even if we invest $10 to match every $1 you invest, we won't be able to catch you in retirement. And were we your parents' age, somewhere from forty-five to fifty-five years old, we'd literally have to invest $20-$40 for your every $1 just to stay even with you in retirement. For every $1,000 you put in, your parents would have to put $20,000-$40,000 just to have as much for their retirement.
The lesson, brothers and sisters, is obvious, is it not? Start now, with a dollar or two here and there, week by week. One less coffee, one less pair of shoes, one less trip to the snack bar, one less CD. The little commitments of today will lead to enormous rewards throughout your life. A thousand dollars a year saved and invested in stocks from ages fifteen to thirty should, based on historical record, generate just shy of $1.5 million in your retirement account.
To summarize, remember that the power of compounding depends on
- how much you invest (and how regularly).
- what your growth rate is.
- how long you let your money grow.
You need not follow neatly any of the examples we've shown. You might start sooner or later. You might invest $300 each year in your first two years, $3,000 in later years, then more as you're able to. You might earn an average yearly return of 10 percent over many decades. Or perhaps your annual return will be 7 percent or 13 percent or more. You can't control every variable, but to a great degree, you can control how much you invest, how you invest, and how long you let your money grow.
Remember also that you can still enjoy your life while you're saving and investing. We're not talking about trading all your old clothes for money on eBay -- though come to think of it, that's not a bad idea. And we're not talking about never buying that brand-new car even though it'll lose the value you paid so incredibly quickly -- though, actually, that's not a bad idea, either. We're not talking about avoiding lottery tickets like the plague -- though why would you or anyone want to throw your money away like that? And we're not talking about renting movies rather than hitting the theaters (and paying six bucks for greasy popcorn) -- though like everything else in this paragraph...maybe that's not a bad idea.
All we're talking about is saving a few hundred or few thousand dollars each year and investing it throughout your lifetime. You can amass great wealth by regularly investing just a portion of your savings -- not all of it. That wealth will probably be the best shot you have at choosing the job you really want in life (many people work out of necessity rather than love), or moving to your favorite island (or perhaps owning it), or helping out the less fortunate in your state (perhaps the greatest reward). Savings and investment wealth will create opportunities for you throughout life. You need only get at this early.
We hope you're convinced that through planning and investing, you can earn your financial freedom and make a good deal of excess cash. It's important to remember why you want to do so, though. You wouldn't want to pursue money for the sake of having money. Don't make your life little. Don't get petty. Don't be a miser. Instead, dream. Think of how you'll use the money to make both your life better and the world a little bit better place to be.
At the beginning of this chapter, you listed some of your goals and dreams. By now you should understand that you'll be able to realize many more of them by investing. So let's dig a little deeper into your thoughts and discover more reasons. Think about what a substantial amount of money will mean to you in your life. Here are some possibilities. Put a check mark next to the ones that ring true for you, then add in others below.
_____ Money will help me do what I want to do in life.
_____ Money will help me enjoy life more.
_____ Money will help me be less stressed out.
_____ Money will help me pursue amazing adventures and opportunities.
_____ Money will help me help others in the world.
_____ Money will help me make my mark on the world.
Obviously, money itself -- the green and the gold of it -- won't make your life better. It won't pursue adventures for you. It won't leave your mark on the world. If it could, you wouldn't have very wealthy people falling into dark depression or even sometimes doing cruel things. Even with money, you'll have to work to be a productive, helpful, happy person. But certainly money can help in the pursuit of your dreams and visions.
Next up, we'll discuss how to make and save money for your future. But before that, pause and recognize that you already know more than most adults about the power of investing! It's true. Tap some of your parents' friends on the shoulder and ask them about the power of compounding applied to money. Ask 'em -- Stumper time! -- to provide a quick explanation of the rule of 72. We suspect you'll be teaching them a lesson or two before your discussion ends. Try not to be too smug about it, eh?
Copyright © 2002 by The Motley Fool, Inc.