Investing 101 teaches you that you need to invest money so that it can start earning you interest and making you money. For every dollar that you invest you can expect to make some amount of return on that dollar. The principle of compounding interest, which Einstein referred to as the eighth wonder of the world, then takes effect when you can start earning interest on the interest. This goes on and on and soon your money is earning exponentially. This is the power of investing early and as much as you can.
Think of it as if that dollar that you invested was a little green person that own, like a nice little leprechaun. He has a baby and names it Interest. Interest then grows up and has kids of his own to carry on the Interest Family name. And so on and so forth, until you have a whole little army of green men working hard just for you.
Our investment goal is to be able to put away and save enough money that our investments are making more money each year than my salary is. As of right now this would mean that, assuming that we can expect an 8% return on our investment each year, we would need to have roughly $750,000 in investments to expect to earn $60,000 a year. Now this is the beauty of investing, once we reach this milestone I can confidently quit my job and rely on out investments to earn our living for me. We will have then reached another level of financial freedom, the freedom to quit working for money because all of my money is working for me and all I have to do is manage my little collection of employees.
In theory it all works out fine and dandy, but in the real world there are going to be hiccups along the way that are going to make this a little more difficult because sometimes these little investment employees don’t always cooperate with your goals. Sometimes they aren’t going to be able to make you a steady 8% return each year. And sometimes they are going to go on strike and you’re going to lose money. These are the times when it’s the most important to remember the purpose behind our investing and keep our perspectives focused on the long term.
I wanted to discuss this a little today because recently the stock market has been rather non-compliant. I was looking at one of my spreadsheets this week and noticed that over the last 4 months we have put a total of $4,665 into our investment accounts but our total investments have dropped from $86,420 to $86,244. Meaning that our investments have lost $4,841 in the last 4 months.
Sure, it’s frustrating to work so hard at earning and saving and see all of that work not paying off but it’s OK because I have our long term goals in mind. We aren’t at a level phase of life that requires us to live off of our investments so I’m not worried that this decline will affect our ability to make ends meet. Worst case scenario I have another 40+ years before I will retire and even be able to touch the 401(k) investments, and I know that this 4 months aren’t going to matter compared to the next 40 years of growth potential. If I was closer to retirement or needing to use this money I would be invested more conservatively so this drop in value wouldn’t have been as bad, but since I have so much time I have chosen to go all in on stocks so I know that I’m going to see a much higher volatility in returns and losses.
I believe in the market and its ability to make me money. It’s a roller coaster that you just have to ride out sometimes but don’t worry too much, it’ll keep coming back. These are good times to learn about your personality and relationship with financial issues. Do you have the fortitude to ride the stock roller coaster or do you need to stay with the lazy river bond ride? Understanding these personality traits early on will save you a lot of stress in the long run.
When your investments go on strike the worst thing that you can do is fire them (sell them) because then you lose all of their potential. Just keep believing in them. Sometimes they just need a vacation to refocus and then they’ll be ready to work overtime when they come back, just watch.
So, what do we do? Nothing different that we always do. We hold true to our investment strategies and schedule. We act as if we have no idea that the market is down and buy as much as we can while the stocks are on sale. Invest for the long term and you’ll be OK.