Suggested reading for a teenage investor-Next Step

Comments

• bee

  March 2017 edited March 2017

  Of all the variables you listed the most powerful is the compounding of interest (5%) over time (50 years). This teenager should try to save as much as possible early in life and then let time and compounded interest work their magic.
  
  Q's to pose to this teenager:
  Could your teenager scrape together $100/month or $1200/year?
  Could this be saved in a Roth IRA (teenager must have earned income)?
  
  If a 16 year old could save $1200/yr for 16 years (until age 32) and then stop contributing, but remain "invested" at an average of 5% a year; at age 64 he/she would have a nice little nest egg for retirement, about $150K.
  At an average of 6.5% it would be twice that amount or about $300K.
  At 10% average return it would over $1M.
  
  Not bad for a $19,200 investment (16 yr saving $1200/year).
  
  This calculator seem to meet your input criteria:
  moneychimp.com/calculator/compound_interest_calculator.htm
• David_Snowball

  March 2017

  $67,928 if you were earning 5% risk-free.
  
  I used the calculator bee points us add and had it calculate $100 initial, $300/year addition (i.e., $25/month), compounded monthly for 50 years. The "compounded monthly" part just means we assume that your April portfolio would have undergone some modest appreciation so your May portfolio will be more than just April + $25.
  
  It's a very imprecise calculation since it does assume all of the additions occur once a year through capital growth occurs, uninterrupted, monthly. The better answer would come from a Monte Carlo simulation. If you're familiar with Excel (Chip and Charles will happily testify to the fact that I am not), one of the faculty at Wabash College has posted a free Monte Carlo add-on for it. The technique also underlies the retirement calculators at T. Rowe Price and Vanguard.
  
  Thanks, by the way, for helping your granddaughter. I've had this same conversation with one of my brothers about why (17 years ago) he should really be putting away $25 or $50 a month for his son's education. I even set up the account and put in some hundreds of dollars to start it. Mostly I got uncertain nods and a long-unfunded account in return. There's some research that suggests we need to visualize our future selves (in some cases researchers use "aging" software to accomplish the task) in order to make this work. Something like, "let's say you've worked like a dog for 40 years and now you find yourself living alone in a house that's too big with a quarter-century of 'vacation' in front of you. What do you imagine you'd want to be able to do or feel?"
  
  For what that's worth,
  
  David
• MJG

  March 2017 edited March 2017

  Hi Bobpa,
  
  I like your plan to incentivize your grand daughter towards a savings program. That's a tough sell, but the necessary first step in providing for a comfortable retirement. Good for you and good for your grand daughter.
  
  But asking for a formula that uses a fixed annual return rate fails to address the risks associated with any investment program. In our uncertain world, returns will surely vary over any specified timeframe. A formula does not capture that variability; a Monte Carlo simulation does.
  
  Your question allows me to once again Beat the Drum Slowly for the application of Monte Carlo tools. They were specifically designed to assess the impact of uncertainties.
  
  Bravo to Professor Snowball for recommending a Monte Carlo site. I'm sure you can use it to demonstrate the range of possible savings outcomes coupled to investment return uncertainties.
  
  Allow me to suggest my favorite Monte Carlo website for the same purpose. Please take a look at the Portfolio Vizualizer website at:
  
  https://www.portfoliovisualizer.com/monte-carlo-simulation
  
  The simulator gives likely end-of-period wealth results almost instantaneously. Just running the code together should interest and impress your grand daughter in real time.
  
  Explore with her some what-if scenarios. Input various average and standard deviation estimated returns rates using the Parameterized input option. The code even permits a fat-tailed distribution option. Show her the value of increasing, or the penalty of reducing, the planned saving schedule. The what-ifs are almost endless and yield sensitivity insights.
  
  This could be a fun and educational project for both of you.
  
  Best Wishes