“Shark Tank” star Kevin O’Leary has some simple advice for anyone who finds investing scary[1]: Just do it. Now.
“When you’re 21 years old, or 20 or 18 or 19 and you start putting aside 10% of what you make, you’ll [have] over $1 million by the time you’re 65,” O’Leary told CNBC[2].
“If no one else is going to worry about your retirement[3], I want you to worry about it.”
He goes on to explain that impulse spending is a real obstacle for many. Unneeded clothing, pricey new wheels, morning coffee from a fancy shop — it’s all money that should be going to your future self.
Ten percent might not sound like a lot, but the reason O’Leary is right is the mathematical fact of compounding interest.
If you save, say, $5,000 in one year, a typical stock market return in a diversified, low-cost index fund means that a year later you will have $5,365.
Let’s say the next year you save nothing additional. But you leave that $365 gain invested.
In 10 years at a typical stock market return your money will more than double, hitting $10,115. That’s because every year your gains are reinvested and growing as well.
Wait another 10 years and you have $20,462. Ten more years and you have $41,396. The money just keeps on doubling with no extra effort at all.
That commonly misunderstood mathematical fact is why $5,000 a year turns into more than $1.2 million over four decades.
Five thousand dollars multiplied by 40 years is $200,000. The extra $1 million is all from compounding interest.
Sandbagged
O’Leary also is a strong proponent using low-cost index style ETFs[4] to do that investing.
Why low cost? Because even less understood than compounding is the concept of negative compounding.
If you buy an expensive mutual fund, one that costs you around 1% of your balance per year in fees, that’s 1% of your entire retirement savings being subtracted each and every year.
It’s not 1% of your savings in that year or 1% of your gain. It’s 1% of everything you’ve ever saved and all the money that you’ve earned from compounding, taken from you.
Thus the effect of a 1% fee in a stock mutual fund is that you lose one-third and up to one-half of your potential gains to the fund’s managers. You’ve effectively sandbagged your own retirement.
Charging high fees is a great deal for the fund managers. They take no risk and receive a significant portion of your gain.
All for doing what? The implicit promise is that they will get you a better return than the stock market alone.
Ironically, those fees mean that the vast majority of active stock fund managers can’t give you a better return, especially after...