Small changes, big impact

February 13, 2013 (3 mins to read)

Does one percent matter?  If you’re watching the balance in your portfolio for one year, the difference between an eight percent return and a seven percent return can be a fair amount of money, but won’t really change your life. But maintain that difference for a generation and the impact will really get your attention.

Let’s let the numbers speak for themselves.  Start with $1 million and earn five percent a year for 25 years. You’ll end up with a tidy sum of $3.5 million. Bump the return up just one notch to six percent for the same period and the total is a far tidier $4.5 million.

The difference between seven and eight percent returns? It’s even more dramatic: $5.7 versus $7.4 million.

Earn an annualized nine percent for 25 years and you’ll have $9.5 million after a generation.

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It’s magic

Whoever invented compounding should win the Nobel Prize, a Super Bowl ring and an Oscar every year. Sure it’s just simple math, but its impact is pure magic for long-term investors.

By controlling expenses, limiting tax exposure, and maintaining the desired asset allocation over the long term, investors can significantly elevate their cumulative wealth.

Of course, there’s a downside too. Subtracting a seemingly puny percent of return each year can cost hundreds of thousands of dollars over long timeframes. NASA scientists faced a similar situation before landing men on the Moon – off 1 inch on Earth, off 1000 miles on the Moon.

Like a trip to the moon, generational investing is a long journey, so staying on course is essential. Next time we’ll take a closer look at the importance of maintaining your target asset allocation.

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