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January 19, 2014

The power of compounding

(Continued)

Investment returns: As you might expect, the rate of return earned on a portfolio affects the growth of the account. If the investor earns 4 percent instead of 5 percent, the ending balance at age 65 would be reduced by about 15 percent, from $3.4 million to just under $2.9 million. Remember, other than building and maintaining a well-conceived investment portfolio, investors have little control over the returns they earn from the financial markets. Good advice for all investors is not to expect to make up for saving too little today by hoping to earn high investment returns in the future.

Time horizon: For the investor, time can be a friend or an enemy. Which of the two depends upon how much has already been saved and how soon the nest egg will need to be tapped. In simple terms, the longer you delay saving the harder it will be to make up for lost time. Wait to start saving from age 25 to age 35 and instead of accumulating $3.4 million you will have only $1.5 million by age 65. Procrastinate until age 45 and the account balance grows to less than $600,000. Viewed another way, in order to build a certain size nest egg for retirement, if you wait until 35 to start saving, you’ll need to save twice as much each year than if you started at 25. Wait until age 45 and you’ll need to save six times as much (a nearly impossible task for most people).

Smart spending, saving, investing and borrowing decisions cannot be made without an understanding of compounding. Those investors who take the time to understand its effect on building wealth will make better financial choices. They will recognize the benefits of saving early and often, choosing the right investments and establishing realistic retirement goals.

John Spoto is the founder of Sentry Financial Planning in Andover and Danvers. For more information, call 978-475-2533 or visit www.sentryfinancialplanning.com.

This article is for general information purposes only and is not intended to provide specific advice on individual financial, tax, or legal matters. Please consult the appropriate professional concerning your specific situation before making any decisions.

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