The Daily Dow
Tuesday, September 2, 1997
by Robert Sheard
LEXINGTON, KY. (Sept. 2, 1997) -- In Friday's column, I wrote about the fact that, at times, paying the taxes on a Foolish Four portfolio as one goes may even be a better option than a tax-deferred 401(k) plan if the only choices you have in the retirement plan are mediocre.
This morning I received a question along a slightly different path, but the same general principles apply regarding the immense value of time. The reader's situation was this: he's 54 years old and a former employee who is due a pension based on contributions he made while enrolled in his former employer's plan.
Now that he's employed elsewhere, he's faced with a choice of three options:
First, he can withdraw the value of his contributions ($4,200) today and forfeit any right to future pension benefits. Second, he can start receiving his pension next year (at age 55), but would receive a smaller annual payment than the full plan calls for ($3,900). Third, he can wait until he's 62 years old and receive the full pension benefit of $6,000 a year. Which would you choose?
Let's assume that regardless of which option he chooses, he's going to sock the money away in a similar investment that earns an after-tax return of 15%, one such as a Dow Dividend Strategy. (He does not need the pension money from this prior plan for daily living expenses.)
If he takes the $4,200 cash pay-out now, he will be making a huge mistake since it stops all future payments. Investing the $4,200 in 1997 at 15% a year, his portfolio would grow to $278,089 after 30 years (in 2026).
If he chooses the second plan and starts taking the pension pay-outs next year (at the reduced level of $3,900 a year) and invests that money each year into the same type of investment, his portfolio would grow to nearly $1.7 million by the year 2026. Obviously much better than option one. In fact, after just two years of the pension benefits, he would have surpassed the other portfolio's three-year growth because by cashing out he only gets a one-time sum (and not a particularly large one).
The third option means he won't get anything until the year 2005, but then he gets $6,000 each year thereafter. By year 2026, though, this option will not have caught up with the portfolio he would have from option two, accepting the reduced benefits but getting them starting seven years sooner. Option three would only have grown to $950,000 by year 2026 (when he's 84 years old). In fact, no matter how long he lives, he'd never catch up with the third option because the annual contributions remain fixed, and as a percentage of a large and growing portfolio, become less and less important. The head start he would get with option two could never be overcome.
Now you may never be faced with such a choice, but the important lesson is the value of time and compounding. Even outside of a pension context, starting early by saving small amounts of money can put you in a better position than starting later with larger amounts. When readers ask me the best time to invest, what I really want to say is "yesterday." Today is the next best option and tomorrow the next best after that. Time is the single most powerful ally we have in creating wealth, even for investors with the most modest portfolios. Anyone who will save even small amounts, given enough time and a Foolish investment approach, will be able to create wealth. So evaluate all your options in any such decision to see which one will benefit you the most down the road. Fool on!
(c) Copyright 1997, The Motley Fool. All rights reserved. This material is for personal use only. Republication and redissemination, including posting to news groups, is expressly prohibited without the prior written consent of The Motley Fool. ________________________________
Stock Change Last -------------------- T +1 1/2 40.50 GM +2 1/2 65.25 CHV +2 15/16 80.38 MMM +1 11/16 91.56
Day Month Year
FOOL-4 +3.39% 4.57% 10.75%
DJIA +3.38% 3.38% 22.20%
S&P 500 +3.12% 3.12% 25.22%
NASDAQ +1.94% 1.94% 25.33%
Rec'd # Security In At Now Change
1/2/97 153 Chevron 65.00 80.38 23.65%
1/2/97 179 Gen. Motor 55.75 65.25 17.04%
1/2/97 120 3M 83.00 91.56 10.32%
1/2/97 479 AT&T 41.75 40.50 -2.99%
Rec'd # Security In At Value Change
1/2/97 153 Chevron 9945.00 12297.38 $2352.38
1/2/97 179 Gen. Motor 9979.25 11679.75 $1700.50
1/2/97 120 3M 9960.00 10987.50 $1027.50
1/2/97 479 AT&T 19998.25 19399.50 -$598.75
CASH $1009.44
TOTAL $55373.57