Time is an investors best friend (or worst enemy if you wait too long) because it gives compounding time to work its magic. Compounding is the mathematical process where interest on your money in turn earns interest and is added to your principal.
Consider the following four investors ages 25 55. Each invests $2,000 per year and earns 8%.
At age 65:
- The investor who started at age 25 has over $585,000
- The investor who started at age 35 has just $250,000
- The investor who started at age 45 has just $98,800
- The investor who started at age 55 has just $30,700
This may not be the most real life example, since we cant go back to age 25 and start over. Lets look at the power of long-term investing from a different goal. What will it take for each of these investors to accumulate $750,000 at age 65, assuming they all earn 8% and ignoring inflation and taxes?
- The investor who started at age 25 needs to invest $213 per month
- The investor who started at age 35 needs to invest $500 per month
- The investor who started at age 45 needs to invest $1,65 per month
- The investor who started at age 55 needs to invest $4,072 per month
Correcting for ProblemsThe examples above describe the mathematical advantage of starting early, however they dont represent a real world situation. It is highly unlikely that you could achieve a constant return of 8% over a long period. The reality is there will be times when your investments earn less and other times when you will lose money. There may also be times when you will earn more.
The investor with a long- term perspective can also correct for mistakes along the way. For example, that stock you thought was going to soar like an eagle turned out to be a turkey. If you have a long-term perspective, you can change investments that arent working for other alternatives. However, if you will need the money from your investment in the near future (fewer than 5-7 years), a mistaken investment can create real problems in meeting your goals.
Long-term investors, especially those who invest in a diversified portfolio, can ride out down markets like the one that began in March of 2000 without dramatically affecting his or her ability to reach their goals.
However, for the investor just starting out at age 55, a market downturn can be disastrous. There is no room for error with only 10 years left before retirement at age 65. The reality of investing is that the market will go up and the market will go down. Investors that begin early and stay in the market have a much better chance of riding out the bad times and capitalizing on the periods when the market is rising.