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Collection: Peter Lynch - #34 'Power of Compounding'



You may be wondering why stocks are so important for a long-term investment program.

The short answer, over time stocks produce better returns than other investments. In the past 60 years, stocks have returned about 10% a year. Bonds have averaged at 6% a year. Treasury bills or Bank CD’s around 3%.

That doesn’t seem like a big difference, does it? But the power of compounding makes an enormous difference over time. Suppose you invest $50 a month and earn 6%. After 30 years you have over $50,000.

Go ahead and play with the numbers yourself. If you clicked on the assumptions button on the previous interactive screens, you noticed that the worksheets do not take taxes into account. When your investment is taxed, the government reduces your return every year.

If you know you won’t need the money until retirement, you should place as much of your investments as possible into tax deferred accounts, like IRAs, Keoghs, 401K or 403b plans. Because you don’t pay taxes on the money until it is withdrawn from the accounts, the power of compounding achieves the maximum effect, providing you the best return possible. The more time you have to let your earnings to compound, the better results you will get.

A 20-year-old who invests $200 a month and earns 10% on his money all along, will have 1.1 million dollars at the time he was 60. A 35-year-old would have to invest $800 a month to have the same 1.1 million dollars at age 60.

You are going to have a tough time getting that 10% return without at least some stocks in your portfolio.



[YAPSS Takeaway]

15 years gap; a 35 years old need to save 4 times of a 20 years old saving to achieve the same amount at the age of 60.

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