3 Things 6-17-24
Thing One
The Rule of 72 (The Simplified View of Compound Interest)
If you divide any expected rate of return (or interest rate) into 72, you will get the number of years it will take your investment, or your debt, in the case you are borrowing money, to double. For instance, if you expect to earn 20% annually on an investment and you put up $100,000, you will have $200,000 in 3.6 years (72 divided by 20), without adding a single new dollar to your investment account. If you carry a balance of $10,000 on a credit card that charges 20% (ignoring late fees and collections issues), in 3.6 years your outstanding balance will be $20,000, without adding a single new purchase to your card. That’s the magic of compound interest, which can be viewed as the interest that interest earns or the debt that debt creates.
The rather obvious advice here is to avoid accumulating debt as much as possible and to invest as early and as often as possible. A recent article we read in Forbes magazine puts a finer point on that advice below:
Give yourself time. With compound interest, the power of time is everything. The sooner you start saving or investing, the longer you give that money to grow. This is why it’s important to start investing for retirement as soon as possible. The earlier you start, the less of your own money you have to save. The bulk of your retirement funds can be grown through compounding.
Pay down debt aggressively. Compound interest works against you when you borrow money, whether that’s via student loans, credit cards or other forms of borrowing. The faster you can pay those down, the less you’ll owe over time.
Compare APYs. The annual percentage yield, or APY, will give you a better idea of what you’ll earn or be charged in interest than the annual percentage rate, or APR. That’s because the APY accounts for compounding, while the APR is the simple interest rate.
Check the rate of compounding. The more frequently an account compounds interest, the more you’ll earn. (Or the more you’ll owe.) Ideally, you want your savings products to compound as frequently as possible and your debts to compound as infrequently as they can.
Thing Two
Choose A Roth 401k At Work If You Can
Readers of this newsletter will be aware of our preference for Roth IRAs over Traditional IRAs. The reasoning is straightforward. Given the magnitude of our country’s existing and growing financial obligations (national debt, unfunded liabilities, growing budget deficits, etc.), our tax obligations as individuals are likely to be greater in the future than they are now. So, if you can pay your income taxes now and avoid paying them in the future, it makes good financial sense.
That’s how Roth IRAs work. Contributions are made on an after-tax basis. The money in the Roth IRA grows tax-free and the withdrawals, including all the capital gains, are tax-free. The same holds true for the Roth 401k, which is the employer sponsored version of the Roth IRA. But, up until the passage of the Secure 2.0 Act, which takes effect in the 2024 tax year, Roth 401k owners had to start taking RMDs (Require Minimum Distributions) at age 73. The distributions were still tax-free, but the tax-free capital gains ended. Now Roth 401k owners can leave the money in the account and have it continue to grow tax-free.
In addition to that, Roth 401k employer matching contributions, which used to get placed into a traditional 401k account prior to the SECURE 2.0 Act, can now be placed into the same Roth 401k and receive the same tax-free growth and withdrawal treatments.
If you have this option at work, you should seriously consider selecting it and you should share the idea with everyone you know who might benefit from it.
Thing Three
Just A Thought
The greatest mistake you can make in life is to be continually fearing you will make one.” —Elbert Hubbard
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