Unlocking Financial Magic! The Time Value of Money and The Rule of 72
Nobel laureate and economist Paul Samuelson once said, “Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.” Although Samuelson is using hyperbole to exemplify his point, it serves as a helpful conversation starter for the nature of investing. Retirement investment accounts benefit from prudent investments, and over a long period of time when possible. Although investing is not devoid of risk, diversified and optimized portfolios provide the groundwork for navigating the ups and downs of an investment journey.
J.P Morgan’s 2024 Guide to Retirement provides a helpful lens to understanding how investments behave over time. J.P Morgan synthesized the returns of the S&P 500 between January 1st, 2004 and December 29, 2023. Capital fully invested over that period would have yielded a compounded return of 9.7%. If that same investor were to pull their investments out during the 10 best days of the market, that 9.7% return would drop to 5.5%. Missing the best 30 days would result in a 0.7% return and missing the 60 best days would result IN A LOSS of 4.3% compounded returns. Furthermore, seven out of the 10 best days occurred within two weeks of the 10 worst days. You see, when investors sell out of the market during the worst times, an investor is likely to miss out on the best days that follow.
A helpful formula to understand the mathematics behind compounded returns is the Rule of 72. The Rule of 72 helps us formulate how many years it would take an investment to double based upon a rate of return. For example, a portfolio with compounding returns of 6% would take 12 years to double in size because 72 divided by 6 is 12. As you are preparing for your retirement journey or future outcomes, this may be a helpful tool as you decide on your goals, desired outcomes, and risk tolerance to see how different return profiles would calculate based on an assumed return.
A concept called the time value of money can also be utilized for projecting out the potential future value of an investments present value over time. With data points of present value, contributions, annual rate of return, and number of time periods, we can project the future value of investments based on those data inputs. You would be surprised how powerful an additional 1% or 2% in returns can be for the future value of investments.
The reality is, investment losses emotionally hurt more than investment gains feel good for most people, but J.P. Morgan’s historical evidence suggests a well-diversified, long-term portfolio can result in a better retirement outcome. Talk to your advisor today if you are interested in learning more about staying invested during this economic climate. Thank you.