Thursday, May 22, 1997
[Today, we revisit a classic fribble from January 1996]
Start Early...Finish
Big
by
TMF Sheard
One of the most frequently asked questions in any year when the stock market has seen big gains is "Should I start investing right now? What if it goes down?" At the risk of incurring the wrath of the market timers, I'm willing to say that it doesn't matter. Start now!
Let's compare two college roommates, Ready Freddy and Slow Joe. Both of them graduated the same year and got similar jobs with similar salaries, but Joe wasn't concerned about his retirement right away. Freddy, though, couldn't wait to start saving some of his new paycheck.
Let's start with Ready Freddy. Each year of the decade from 1961 to 1970, Freddy invested $2000 into an account which mirrored the Dow Jones Industrial Average. (For the sake of simplicity, let's assume it's a tax-deferred and commission-free account.) At the end of ten years, Freddy stopped making deposits and simply let the account continue to grow along with the DJIA. His total investment over 10 years was $20,000.
Slow Joe, on the other hand, didn't start investing for retirement until a decade later. He started putting $2000 a year into the same investment fund Freddy used, but Joe decided to make up for his late start and deposited $2000 a year for two decades instead of Freddy's one, every year from 1971 through 1990. His total investment was $40,000.
At the end of 1995, Ready Freddy's account would be worth $547,322 while Slow Joe's would be worth only $419,650, despite the fact that Joe made twice as many deposits as Freddy.
Now if we change those annual returns to take advantage of the Beating the Dow four-stock approach (equal weighting of stocks #2-5), the gains are even more impressive. Slow Joe's $40,000 investment grew to $1,359,047. But Ready Freddy's $20,000 investment grew to $2,683,353.
The most remarkable development is that the 1960s (the period of Freddy's 10 deposits) was a lousy period for Beating the Dow. At the end of Freddy's 10 years of deposits, his total portfolio was only worth $21,626 because four of the ten years were losing years for Beating the Dow. Nevertheless, having saved the $20,000 early in his career, Freddy took advantage of the magic of compounding.
Even though he invested less money than Joe, and at a worse time in the market, his total portfolio grew to significantly larger proportions simply because he started early. So, if you're worried about market timing and your history of rotten luck, think of Ready Freddy. It pays in a big way to get an early start and to wait patiently for the compounding clown to dance.
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