A group of college students talk outside of a building.

Let the Compounding Commence!

Every year, families and friends celebrate students who are graduating from colleges and universities. Parents beam with pride at their children’s accomplishments and exhale in relief now that the tuition bills have finally stopped. It is a time when adults give a lot of advice, which is why I have one simple idea I want to pass along to this year’s graduating class that I hope you never forget. Parents, take note as well, because with college out of the way, you can get back to focusing on retirement.

Let the compounding begin!

In case you did not come across this idea in an econ class, let me explain compounding simply. It is the process by which the value of an investment increases over time as earnings or interest are reinvested. It is the snowball effect but with money. Here is an example.

If you are a US investor and lucky enough to have up to $35,000 left over in your 529 college savings plan, you can roll it over into a Roth IRA starting in 2024, provided the account has been open at least 15 years.(1)  If you do not touch that $35,000 for 50 years, and the market averages a 10% annualized return, which is close to its long-term historical average, then guess how much you’ll have? (2)

A. $1,584,074
B. $2,551,167
C. $4,108,680

The answer is C. Over $4.1 million!

If you were to start this in your mid-20s and invest that same initial amount for only 45 years, you would end up with B, or $2.6 million. That is great, but not as great as C.

If you do it for 40 years, you will end up with A, or $1.6 million. Also good, but, you know, not C.

Another benefit of compounding is that it can help you pursue financial goals along the way, like making a down payment on a home. But do not worry if you spent your whole college fund or took out student loans. Start with a little and get in the habit of adding when you can. As you can see from this snowballing, having a lot of time can help make up for not having a lot of money.

In addition to increasing the value of your investments, compounding can also be a valuable force in life. For example, you have made an investment in time and money over the last few years that may have an enormous effect on the rest of your life. How much money are we talking about? College graduates, on average, earn 84% more than those with a high school education, and that adds up to an extra $1.2 million over a lifetime. (3) Parents, I hope you are feeling a little better about your investment too.

But it is more than just money. When you get to be like me, someone who graduated from college more than 50 years ago, you see that you are the result of the compounding of your life’s decisions, both good and bad. It is hard to quantify exactly, but it is sure there. For example, in graduate school, I decided I did not want to be a professor. That one decision continues to have a profound impact on the rest of my life. Instead, I started a company with the people I met in graduate school. Four decades later, I am still working with some of them. I even got to go watch my former professor and current colleague Eugene Fama receive a Nobel Prize in Economic Sciences. That was not on my bingo card when I graduated from college. Life is full of surprises, and many of them can come from how your decisions compound over decades.

So, start rolling your snowball, both in life and in investing. Let the compounding commence!

Shore Point Advisors

This post was written by David Booth (Executive Chairman and Founder of Dimensional Fund Advisors). This article was also first distributed by Dimensional Fund Advisors. Shore Point Advisors adheres to a similar investing philosophy to the one that is implemented by Dimensional Fund Advisors, which is the reasoning for the reposting of this article. 

FOOTNOTES

(1) Laura Saunders, “Your Child Picked a College! Tee Up Your 529 Plan,” Wall Street Journal, May 5, 2023.

(2) In US dollars. Based on S&P 500 Index annual returns, 1926–2022. S&P data © 2023 S&P Dow Jones Indices LLC, a division of S&P Global. All rights reserved. Indices are not available for direct investment; therefore, their performance does not reflect the expenses associated with the management of an actual portfolio.

(3) “How Does a College Degree Improve Graduates’ Employment and Earnings Potential?” Association of Public and Land-Grant Universities.

DISCLOSURES

The investment approach discussed does not assure a positive return or a positive investment experience. There are numerous ways of approaching investing, only one of which is presented here, which may not be appropriate for every individual.

529 Plans are tax-advantaged savings plans available in the United States that are designed to help pay for education.

Eugene Fama is a member of the Board of Directors for and provides consulting services to Dimensional Fund Advisors LP.

The information in this material is intended for the recipient’s background information and use only. It is provided in good faith and without any warranty or representation as to accuracy or completeness. Information and opinions presented in this material have been obtained or derived from sources believed by Dimensional to be reliable, and Dimensional has reasonable grounds to believe that all factual information herein is true as at the date of this material. It does not constitute investment advice, a recommendation, or an offer of any services or products for sale and is not intended to provide a sufficient basis on which to make an investment decision. Before acting on any information in this document, you should consider whether it is appropriate for your particular circumstances and, if appropriate, seek professional advice. It is the responsibility of any persons wishing to make a purchase to inform themselves of and observe all applicable laws and regulations. Unauthorized reproduction or transmission of this material is strictly prohibited. Dimensional accepts no responsibility for loss arising from the use of the information contained herein.

This material is not directed at any person in any jurisdiction where the availability of this material is prohibited or would subject Dimensional or its products or services to any registration, licensing, or other such legal requirements within the jurisdiction.

RISKS

Investments involve risks. The investment return and principal value of an investment may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original value. Past performance is not a guarantee of future results. There is no guarantee strategies will be successful.

DISCLAIMERS

This material is intended for general public use. By providing this material, we are not undertaking to provide investment advice for any specific individual or situation, or to otherwise act in a fiduciary capacity. Please contact one of our financial professionals for guidance and information specific to your individual situation. This is not an offer to buy or sell a security.

Shore Point Advisors is an investment adviser located in Brielle, New Jersey. Shore Point Advisors is registered with the Securities and Exchange Commission (SEC). Registration of an investment adviser does not imply any specific level of skill or training and does not constitute an endorsement of the firm by the Commission. Shore Point Advisors only transacts business in states in which it is properly registered or is excluded or exempted from registration. Insurance products and services are offered through JCL Financial, LLC (“JCL”). Shore Point Advisors and JCL are affiliated entities.

SHARE THIS POST!

Facebook
Twitter
LinkedIn
Email