Next, there is a comparison for someone who didn’t start as early – contributing $5,000 each year for 30 years and earning 10% annually, comes out to only $904,717. A difference of $1,529,542!
The time aspect of compound interest has hopefully been beaten into your head over and over again. I’m going to assume you understand how important it is to start today, no matter your age.
However, time is only 50% of the equation. The annual return aspect is often neglected, but just as powerful.
What if you were to earn an 11% return on your investment? After 40 years of investing $5,000 each year and earning 11% annually, you would accumulate $3,229,135. There is a difference of $794,876 between a 10% and 11% return over 40 years.
Your objective as an individual investor is to do everything you can to earn that extra 1%. Below are two common ways that you can increase your return, without increasing your risk.
Rebalancing is too often ignored by the individual investor. That’s a shame because it’s the only opportunity to increase return without increasing your risk.
As an individual investor, you need to learn the principles behind rebalancing. Even if it increases your total return by only .5% over 40 years, you saw the difference that makes. If you have a simple rebalancing strategy, all it takes is 15 minutes a year.
If the thought of rebalancing sounds too complicated, just invest in a good target retirement. Your problem will be solved.
Fees and Expenses
When Benjamin Franklin said, “A penny saved is a penny earned” a few centuries ago, I don’t think he was talking about mutual funds. However, his advice still applies.
Earning 1% more on your investment over 40 years isn’t all about increasing your return. It’s just as important not to decrease your returns through expenses.
An investment expense can come at you in many different ways.
Here are some of the more common:
- Adviser Fees
- Sales Charges – Front and back-end loads
- Account service fees
- Mutual Fund fees
For a more detailed description, the SEC has a solid guide to investment expenses.
You need to know about every single penny that is coming out of your investment. Your goal is to minimize expenses as much as possible.
There are many things you can’t control when it comes to investing. Rebalancing and investment costs are one of the few things you can control.
If you can earn an extra .5% through rebalancing and save .5% by minimizing your expenses, you will have earned an extra $794,876 in 40 years.