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Fund Family Shareholder Association
www.adviseronline.comno requirement on distributions—if
you don’t feel like taking money out or
don’t need it, you can leave it in there
to continue growing.
Why do I continue to preach the
benefits of IRAs as great starter invest-
ments for teenagers or young adults?
Simple: Taxes and the power of com-
pounding. If your child is only working
for the summer, or just starting their
professional career, they will likely be
in one of the lowest tax brackets, mak-
ing it a fantastic deal to pay taxes on
their retirement savings now as opposed
to when they are older and in a higher
bracket. And, in this economy, many
first-time jobs don’t come with 401(k)
retirement plans attached, so there’s no
other available vehicle for forced retire-
ment saving. Plus, for most, an IRA
gives you more flexibility over where
and how to invest. 401(k)s often have
few, and sub-par, investment choices.
The power of compounding is what
really makes any kind of tax-deferred
investment smart. The definition of
compounding is “the act of generat-
ing earnings from previous earnings.”
While I know you know what that
means, here’s how I’d think about
explaining it to a younger investor:
Let’s say you make a $100 investment
in a fund that rises 20% in a year. After
that year, you’d have $120. Instead of
selling your shares, you let them ride,
and the fund gains another 20% the
next year, bringing your investment
value up to $144. That’s an additional
$4 in gains over the first year (or 4% on
the initial $100 investment) generated
because you gained 20% not only on
your original investment, but also 20%
on all the money you earned in the first
year. While this may not seem like an
impressive amount, with each pass-
ing year that earnings potential grows
even higher, so long as the investment
prospers. If you start actively investing
a set amount each year, adding to the
amount generated by what the invest-
ment earns on its own, you create even
larger potential earnings.
In the table on page 12, I set up
several different savings scenarios for
illustration. All of them assume a 6%
annual return, with the difference in
scenarios being the amount contrib-
uted per year, increasing in increments
from $1,000 to $5,500 (the maximum
currently allowed under IRS rules for
investors age 49 and younger for 2015
and 2016) from the age of 15 to 70.
Finally, the sixth scenario attempts
to show a conservative, natural progres-
sion a young person might follow as
they age and gain employment: Starting
with their first summer job at age 15,
they invest $1,000 a year until they
graduate from college and get settled
into a career, bumping their contribu-
tion up to $2,000 a year at 23. By age
30, they will (hopefully) be well-estab-
lished and able to again bump their
contribution up to $4,000, and by 40,
to $5,500, an amount they continue to
contribute up until retirement.
You can see that the greater the con-
tribution and the greater the time that’s
passed, the larger and faster the account
grows. That is the power of compound-
ing—by constantly adding to your
investment, you increase the potential
return, going from what seems like a
paltry $1,000 initial investment at age
15 to $225,000 by age 60, simply by
adding $1,000 a year to the account,
achieving a 6% annual return and pay-
ing no taxes on your income and gains.
With larger initial (and subsequent)
investments, you get even more bang
for your buck.
But I also put together another sce-
nario that may be more realistic, par-
ticularly when we’re talking about real
markets and real teenagers. First off,
few teenagers are going to be able to
earn $5,500 in a summer, though they
might be able to hit that number or high-
er if they work during the school year.
Also, as you know, markets don’t
compound in a straight line. They go
up and down. So, in the charts at the
bottom of page 12, I’ve assumed that
our teen (or guardian angel) is not only
socking away more modest sums, but
does so from the age of 12 to the age
of 25, when, presumably, Junior will be
out working, saving and investing on
his or her own.
In the three scenarios, I’ve assumed
the actual returns from
Total Stock
Market
,
Total Bond Market
and
Wellington
from 2002 through 2015.
Despite two stock bear markets
during this period, Wellington, which
keeps about 60% of assets in stocks
and the remainder in bonds, beat the
returns from Total Bond Market and
came close to matching those from
Total Stock Market.
These charts might be just the thing
to show the teen or young adult you’re
interested in leading down the road to
retirement. I hope I’ve both made the
benefits of funding an IRA clear, and
simplified it enough that a young inves-
tor can understand it. But the question
remains: How can we get a teenager to
save for retirement?
You probably can’t. So, my advice
is to help them. That’s what I did with
both of my kids.
Let’s assume you can afford to
match their summer earnings. Do it.
>
LOW COSTS
Saving a Tree?
VANGUARD IS NOTORIOUS for cutting expenses to keep
the fees on its funds and ETFs rock-bottom. Well, I’ve got
a suggestion: Try cutting back on envelopes.
No, I’m not talking about the self-mailers that
Vanguard used to include with account and transaction
statements. I’m talking about the envelopes surrounding
the envelopes.
I recently emailed Vanguard asking for some self-
mailers because, well, they hadn’t sent me any in a while. I think a picture speaks a thousand
words, so all I’ll say is, when 21 envelopes are packed in seven envelopes and then packed in
one envelope, well, maybe Vanguard still has room to trim the fat.