How a little equals a lot.

It’s not uncommon to hear people say they don’t have any money for investing.  Alternatively, folks may also lament they can’t save enough to make a difference, so why bother.  Are these valid statements?  Possibly.  Then again, potential investors may need only to sharpen their budget pencils or realize how little investments can generate a large return over time.

There are plenty of resources available to help people hone their budgeting skills.  I’m sure I’ll touch on more in this blog in the future.  For today, however, I wanted to look specifically at the power of small dollar amounts working over a long period.

For this exercise, I used Excel’s Future Value (FV) function to look at the difference $25 a month can make.  Why $25?  Because that’s an achievable goal.  Reaching it requires foregoing a couple fancy coffees and one or two fast food lunches each month to save enough to clear the bar.  Over 20 years of working life, the difference in foregoing small expenses may be significant.

In the example below on the left, a new college graduate with $1,000 invests it in a few Dividend Champions yielding 4% annually.  In the example on the right, the new grad’s fellow classmate also puts $1,000 into a mix of Dividend Champions and makes it a habit to save $25 each month.  Each quarter the $75 saved is invested in a Champion.  Both continue their respective tracks for 20 years or 80 quarters.

The way FV formulas work, payments into the formula e.g., initial investment and subsequent quarterly payments, are shown as negative figures (in parentheses) while money received out is recognized as a positive figure. 

The periodic interest rate in this exercise is quarterly and equals an annual rate or dividend yield of 4%.  For example, 4% divided by 4 quarters equals a 1% quarterly rate.

Save $0 / Mos.		Save $25 / Mos.
$       (1,000)	Present Value (PV) Initial Investment	$       (1,000)
1.0%	Quarterly Interest Rate	1.0%
80	Periods	80
$                -	Quarterly Investment	$             (75)
$2,216.72	Future Value (FV)	$11,342.08

The graduate who invested $1,000 in stocks yielding 4% and added nothing to it realized just over $2,200 after 20 years.  Conversely, the student who started with $1,000 and made it a habit to save $25 each month, investing $75 each quarter, finished with over $11,300 during the same period.  The second investor saw her modest nest egg grow to more than 5 times that of her classmate.

Now you may be thinking, “Why bother with $11,000+ over 20 years?”  The answer is this is a conservative scenario.  As people’s careers progress and earnings grow, the amount available to contribute each month grows as well.  Of course, having this money to invest assumes investors are disciplined enough to keep plugging away.

What happens if the average amount an investor can save goes from $25 a month to $100 and she continues to make quarterly purchases?  At the end of 20 years she’ll have over $38,700; more than 17x the size the account her fellow grad has.  What if she does really well, saving an average of $200 each month during the 20 year period, purchasing $600 worth of Dividend Champions each quarter?  She’ll have over $75,000 and a sum nearly 34 times larger than her counterpart.  Is it realistic to save $200 per month?

The median income (half made more, half made less) in the U.S. in 2017 was $31,782.  Saving $200 per month equals $2,400 a year or 7.5% of the total median income.   Although it may be difficult for some to save and invest that much, it’s not impossible for many to manage if they decide their financial future is important enough to work at it.

In the end we all have decisions to make.  For some, the immediacy of a frothy coffee and bagel twice a week is more important than the well-being of their future selves.  For others, the decision is the opposite.  Knowing the long-term effects of persistent saving and investing can make a difference in the decisions we make today and the life we live tomorrow.  This is why it’s important to understand how a little equals a lot. 

The thoughts expressed here are those of the author, who is not a financial professional.  Opinions should not be considered investment advice.  They are presented for discussion and entertainment purposes only.  For specific investment advice or assistance, please contact a registered investment advisor, licensed broker, or other financial professional.