Jennifer Openshaw, CEO of Family Financial Network and author of The Millionaire Zone

The stock market has risen relentlessly, and real estate and commodity markets have peaked. It’s a good chance to park some cash, as a lucky few did in the late 1990’s. Are bonds the answer? That’s for you to decide. But just as the Internet and e-broker platforms revolutionized stock investing ten years ago, now it’s becoming easier for individual investors to invest in individual bonds. Here’s why.

Historically, bond investing has been the domain of institutions and a handful of elite brokers. Try to buy an individual bond and you’ll be amazed at what you will - or won’t find. Wholly designed for institutional players, bond investing tools resemble a visit to the dungeon in Hogwart’s Castle: weird terminology and acronyms flying around like energized bats and a strong sense that many bond features, research or record of previous trading are forever hidden behind closed trap doors.

And if you happen to find a bond you like you won’t necessarily be able to buy it - unless some dealer just happens to have a few lying around.

As a result, bond mutual funds have been the “push” of most investment advisors. But it’s a steep 20 percent admission charge to attend the party - 80 to 150 basis points (0.8%-1.5%) in management fees on an investment designed to earn about 5 percent in the first place.

This is hardly a consumer friendly choice. I’ve always thought it odd that one of the market’s safest havens is so difficult for the individual investor - at least until now.

An Open Bond Market

For years, individuals could buy U.S. Treasury savings bonds online easily through Treasury Direct (see www.savingsbonds.gov) . But that was about it. Discount and so-called “premium discount” brokers have made what’s best described as a slow push into electronic individual bond investing. Of those I checked out, Fidelity and its Open Bond Market platform introduced in late 2004 seem to have come the farthest.

The Open Bond Market brings many of the features sought by stock traders to an individual’s fingertips: research capability, selection tools, price transparency and trading history. Further, the Fidelity platform provides liquidity by adding the inventory of some 80 plus dealers and some 10,000 issues, cutting out the painful search for a dealer with inventory at an acceptable price.

What’s Under the Hood

The Internet stock trading platforms of the late 1990’s were made possible by repackaging tools previously used by professional traders. And so it is with Fidelity and most of the others. A rapidly growing Wall Street firm known as MarketAxess (NASDAQ: MKTX) has built a electronic bond trading platform incorporating information, analytics, and price and trade history for investment grade and high-yield corporate bonds for institutional investing clients. Known as Corporate BondTickerTM, platform elements are now being adapted to retail by Fidelity and others.

The appearance of real time information has had a tremendous impact on price transparency and trading efficiency in the market. According to MarketAxess spokesman Stephen Davidson, quoting a recent study, some $1 billion in trading cost savings has been realized by institutional clients annually. He adds: “The secret is providing transparency, price discovery and superior liquidity investors seek.” MarketAxess currently handles some 90% of electronic investment-grade corporate bond trading today, of which only 8-10% currently is brought in through the retail channel. While MarketAxess itself currently has no plans to enter the retail trade, you’re likely to see a growing presence of efficient and retail-friendly e-platforms built upon new the functionality that supports Corporate BondTickerTM.

Using The Tools

I’ll be the first to point out that, even with better tools, buying individual bonds isn’t for everyone. Credit risk makes bond diversification very important. That combined with the use of laddering to spread maturities and reduce interest rate risk means that individual bond investing probably isn’t for smaller portfolios.

But if you have a larger portfolio, say $100,000 or more, it’s worth checking out these tools. Even if you’re not at that “number,” it’s not a bad idea to learn about these tools and bonds in general.

Fidelity has done a nice job of bundling the tools and making them easy to use. The Bond Selector, found at http://fixedincome.fidelity.com/fi/FISearchIndividualBonds lets you select among a wide assortment of issuers and bond types. Important features include:

• Screener. Narrows the search to certain types of bonds, yield ranges, and risk ratings. Also allows selection of Fidelity “Tier 1″ - a group of issues pre-screened by Fidelity for quality.

• Industry selector. For corporate bonds, you can choose one or more industries

• Risk-reward tools. The handy “scatter graph” lets you visually pick you spot on the yield curve. Mouseovers reveal the individual bond and agency rating for each point on the scatter graph.

• Laddering tool. Visually construct a bond portfolio to meet income needs and risk parameters over a longer term.

• Reduced commissions. Online trades cost $0.50 each for U.S. Treasuries (free for initial auction Treasuries) to $2 for corporates with a minimum of $19.95 per trade.

Anyone intending to buy individual bonds should take the time to learn bond investing techniques and strategies. E-broker educational tools are a good place to start. I also recommend the instructive American Association of Individual Investors frequently-asked-questions page, found at http://www.aaii.com/faqs/bonds.cfm.

Reinventing the Bond Market

Creating a friendlier and more level playing field for do-it-yourself individual investors is the whole idea, and there are signs it’s working. According to Fidelity Senior Vice President for Retail Fixed Income Securities Andy Wrobel, some 80 percent of Fidelity’s retail client bond trades are now done online rather than through brokers. This compares to 30 percent when the Open Bond Market started out. Customer response has been “overwhelming.”

Wrobel adds: “Our goal was to reinvent the bond market for the retail customer. The bond market was like buying a car 10 years ago; with no real time Blue Book or any other tool you never knew if you were getting a good deal. That’s changed now.”

It’s still in the early stages, and I don’t expect people to ever trade bonds like stocks. But so far as expanding possibilities for individual investors, I believe he’s right.

The stock market has risen relentlessly, and real estate and commodity markets have peaked. It’s a good chance to park some cash, as a lucky few did in the late 1990’s. Are bonds the answer? That’s for you to decide. But just as the Internet and e-broker platforms revolutionized stock investing ten years ago, now it’s becoming easier for individual investors to invest in individual bonds. Here’s why.

Historically, bond investing has been the domain of institutions and a handful of elite brokers. Try to buy an individual bond and you’ll be amazed at what you will - or won’t find. Wholly designed for institutional players, bond investing tools resemble a visit to the dungeon in Hogwart’s Castle: weird terminology and acronyms flying around like energized bats and a strong sense that many bond features, research or record of previous trading are forever hidden behind closed trap doors.

And if you happen to find a bond you like you won’t necessarily be able to buy it - unless some dealer just happens to have a few lying around.

As a result, bond mutual funds have been the “push” of most investment advisors. But it’s a steep 20 percent admission charge to attend the party - 80 to 150 basis points (0.8%-1.5%) in management fees on an investment designed to earn about 5 percent in the first place.

This is hardly a consumer friendly choice. I’ve always thought it odd that one of the market’s safest havens is so difficult for the individual investor - at least until now.

An Open Bond Market

For years, individuals could buy U.S. Treasury savings bonds online easily through Treasury Direct (see www.savingsbonds.gov) . But that was about it. Discount and so-called “premium discount” brokers have made what’s best described as a slow push into electronic individual bond investing. Of those I checked out, Fidelity and its Open Bond Market platform introduced in late 2004 seem to have come the farthest.

The Open Bond Market brings many of the features sought by stock traders to an individual’s fingertips: research capability, selection tools, price transparency and trading history. Further, the Fidelity platform provides liquidity by adding the inventory of some 80 plus dealers and some 10,000 issues, cutting out the painful search for a dealer with inventory at an acceptable price.

What’s Under the Hood

The Internet stock trading platforms of the late 1990’s were made possible by repackaging tools previously used by professional traders. And so it is with Fidelity and most of the others. A rapidly growing Wall Street firm known as MarketAxess (NASDAQ: MKTX) has built a electronic bond trading platform incorporating information, analytics, and price and trade history for investment grade and high-yield corporate bonds for institutional investing clients. Known as Corporate BondTickerTM, platform elements are now being adapted to retail by Fidelity and others.

The appearance of real time information has had a tremendous impact on price transparency and trading efficiency in the market. According to MarketAxess spokesman Stephen Davidson, quoting a recent study, some $1 billion in trading cost savings has been realized by institutional clients annually. He adds: “The secret is providing transparency, price discovery and superior liquidity investors seek.” MarketAxess currently handles some 90% of electronic investment-grade corporate bond trading today, of which only 8-10% currently is brought in through the retail channel. While MarketAxess itself currently has no plans to enter the retail trade, you’re likely to see a growing presence of efficient and retail-friendly e-platforms built upon new the functionality that supports Corporate BondTickerTM.

Using The Tools

I’ll be the first to point out that, even with better tools, buying individual bonds isn’t for everyone. Credit risk makes bond diversification very important. That combined with the use of laddering to spread maturities and reduce interest rate risk means that individual bond investing probably isn’t for smaller portfolios.

But if you have a larger portfolio, say $100,000 or more, it’s worth checking out these tools. Even if you’re not at that “number,” it’s not a bad idea to learn about these tools and bonds in general.

Fidelity has done a nice job of bundling the tools and making them easy to use. The Bond Selector, found at http://fixedincome.fidelity.com/fi/FISearchIndividualBonds lets you select among a wide assortment of issuers and bond types. Important features include:

• Screener. Narrows the search to certain types of bonds, yield ranges, and risk ratings. Also allows selection of Fidelity “Tier 1″ - a group of issues pre-screened by Fidelity for quality.

• Industry selector. For corporate bonds, you can choose one or more industries

• Risk-reward tools. The handy “scatter graph” lets you visually pick you spot on the yield curve. Mouseovers reveal the individual bond and agency rating for each point on the scatter graph.

• Laddering tool. Visually construct a bond portfolio to meet income needs and risk parameters over a longer term.

• Reduced commissions. Online trades cost $0.50 each for U.S. Treasuries (free for initial auction Treasuries) to $2 for corporates with a minimum of $19.95 per trade.

Anyone intending to buy individual bonds should take the time to learn bond investing techniques and strategies. E-broker educational tools are a good place to start. I also recommend the instructive American Association of Individual Investors frequently-asked-questions page, found at http://www.aaii.com/faqs/bonds.cfm.

Reinventing the Bond Market

Creating a friendlier and more level playing field for do-it-yourself individual investors is the whole idea, and there are signs it’s working. According to Fidelity Senior Vice President for Retail Fixed Income Securities Andy Wrobel, some 80 percent of Fidelity’s retail client bond trades are now done online rather than through brokers. This compares to 30 percent when the Open Bond Market started out. Customer response has been “overwhelming.”

Wrobel adds: “Our goal was to reinvent the bond market for the retail customer. The bond market was like buying a car 10 years ago; with no real time Blue Book or any other tool you never knew if you were getting a good deal. That’s changed now.”

It’s still in the early stages, and I don’t expect people to ever trade bonds like stocks. But so far as expanding possibilities for individual investors, I believe he’s right.

Reprinted with the permission of:

Jennifer Openshaw

The Millionaire Zone
6 West Putnam Ave, Third floor
Greenwich, CT 06830

http://www.themillionairezone.com/

The opinions and views expressed in this document do not necessarily reflect the views or opinions of InvestingMinds. InvestingMinds did not prepare and does not endorse such content. Please note that this document is intended for general circulation only and the recommendations contained herein do not take into account the specific investment objectives, financial situation or particular needs of any particular person. This document is for information purposes only and it should not be regarded as an offer to sell or as a solicitation of an offer to buy securities or other financial instruments. No part of this document may be reproduced in any manner without the written permission of InvestingMinds.

Once you retire, if you start drawing from your investment and savings accounts in the wrong order, you greatly increase the odds that your money will run out or that your heirs will be left with less than they could have inherited.

Common mistake: Many retirees as­sume that they should start withdraw­ing money from their IRAs, 401 (k)s and other retirement accounts as soon as they retire-retirement is, after all, what this money is intended for.

Reality: Your financial future could be a lot brighter if you leave retirement accounts un­touched for as long as govern­ment rules and your financial situation allow. That way, you sharply reduce your annual tax payments.

Example: Two people retire at age 65. Each has a total of $1.4 million-$1.1 million in retirement accounts, such as IRAs and 401(k)s, and $300,000 in taxable nonretirement accounts. Each earns an 8% annual return on his/her overall investments and-drawing on both principal and investment re­turns-spends $8,000 per month on expenses. How they diverge: Mr. A starts living off his retirement accounts as soon as he retires-and sees his sav­ings run out at age 98. Ms. B lives off her taxable investments for as long as possible before tapping tax-protected retirement accounts-and still has $1.2million remaining at age 98 (see chart).

THE BEST ORDER

Once a retiree passes age 70 1/2, gov­ernment rules require specific minimum annual withdrawals from most tax-deferred retirement accounts, including traditional IRAs and 401 (k)s. A retiree’s tax bracket, health and personal priori­ties can alter the order in which assets should be withdrawn. These caveats aside, most retirees should tap accounts in roughly the fol­lowing order…

1. Taxable income. Pension distri­butions, earned income from re­tirement jobs and income from divi­dends and interest in accounts other than IRAs and 401 (k)s should be spent first. If you already have begun to receive Social Security payments, that money should be used as well (If you have not yet started receiving your Social Security benefits, see item 4 below.)

2. Traditional IRA and/or tradition­al 401(k) distributions if your tax bracket Is low. This is an exception to the general rule that you should leave tax-deferred retirement accounts untouched for as long as possible. If your retirement income is low enough to keep you in the 10% or 15% tax bracket, withdraw money from your tax-deferred retirement savings just un­til you reach the taxable income limit of the 15% tax bracket. In 2007, the limit is $63,700 for a married couple filing jointly and $31,850 for an individual. Example: After deductions, a retired married couple’s taxable investment income, pension benefits and other retirement income total $50,000 for 2007. They withdraw $13,700 from their traditional IRA and remain in the 15% tax bracket.

Better: If you can live without this income for now, instead of taking a distribution, convert a portion of your traditional IRA to a Roth IRA (whose assets will never be taxed in the future), but not so much that the converted as­sets push you out of the 15% tax brack­et. (The converted assets count toward your income for tax purposes.)

3. Taxable investments and savings. Among these assets-including stocks, bonds and mutual funds outside of retirement accounts-there are three basic steps to consider…

First, sell those that have dropped in value and are no longer attractive so that you can use the capital losses to offset capital gains.

Second, draw on any assets that are in cash (including money market funds) and fixed-income investments, such as matured bonds and matured certificates of deposit (CDs). By reduc­ing these assets, you lower the amount of taxes you pay on future interest and dividends. If this action shrinks your overall allocation for fixed-income investments, you can raise the amount of fixed-income investments you have in IRAs and 401 (k)s.

Third, sell taxable investments that have appreciated in value but are no longer attractive, especially those that have appreciated the least. Any long ­term capital gains-on assets held for more than one year-are taxed at no more than 15%.

4. Social Security benefits. Retirees who have not yet begun to receive Social Security benefits might consider delaying the start of their benefits until as late as their 70th birthdays if they can afford to do so.

Retirees can receive Social Security checks at age 62. However, the size of the checks will increase by 7%, 7.5% or 8%-depending on the year the retirees were born-for each year they delay from age 62 until 70. There is no ad­vantage to delaying the start of benefits past age 70. Retirees who will benefit from waiting…

Have enough other retirement as­sets and income to cover their expenses and don’t have to dip into their tax-deferred retirement accounts (except as mentioned in item 2) and…

Are healthy and come from families in which members tend to live a long time. The longer you expect to live, the more sense it makes to delay the start of Social Security benefits. If your health or family history suggests that you might not live much past age 84, start benefits by age 66.

5. Traditional IRAs, 401(k)s and oth­er tax-deferred retirement accounts. Withdrawals from these accounts gener­ally should be delayed as long as possible to take maximum advantage of tax-deferred investment growth. Eventually, however, either your financial situation or tax rules may force you to start with­drawing money.

Strategy I: Married couples who must tap into tax-deferred accounts before tax laws require should draw on the older spouse’s accounts first. That way, the older spouse will have already met part of the minimum required distribution.

Strategy II: Tax laws typically require that annual withdrawals from tax-deferred retirement accounts begin April 1 of the calendar year following the year in which the retiree turns 70 1/2. Most retirees, however, should begin taking withdrawals in the same calendar year that they turn 70 1/2, not the one after. That way, you don’t end up taking two required distributions - the initial one and the second one - in a single year, which could push you into a higher tax bracket. (See IRS Publication 590, Individual Retirement Arrangements, or www.paytaxeslater.com/calculator to calculate required withdrawals.)

Exceptions: Minimum required distributions from a traditional 401(k) often can be delayed as long as you are still working for the company that sponsors the 401(k). You also might be able to delay minimum distributions until age 75 on contributions made before 1987 to a 403(b), a type of retirement account offered by nonprofit organizations.

6. Roth IRAs. Assets held in Roth IRAs and Roth 401(k)s generally shouldn’t be spent until all other assets have been exhausted, because there are no future taxes on Roths - including on investment gains - even for heirs. And there are no minimum required distributions for you or your surviving spouse from your Roth IRA. To avoid minimum required distributions on your Roth 401(k)s, roll them into your Roth IRA.

Types of Accounts

Tax-deferred retirement ac­counts. These include traditional IRAs and 401(k)s for which taxes have not yet been paid. No taxes are paid as long as the money remains in the account, but taxes must be paid at regular income tax rates on any with­drawals, including interest, dividends and even capital gains.

Roth IRAs and Roth 401(k)s. Tax­es were paid before the initial contri­butions were made, and no further taxes will ever have to be paid on the initial contributions or the interest, dividends and gains (as long as cer­tain conditions are met).

Reprinted with the permission of:

Bottom Line/(name of publication/website)

Boardroom, Inc.
281 Tresser Blvd, 8th Floor
Stamford, CT 06901
www.BottomLineSecrets.com

The opinions and views expressed in this document do not necessarily reflect the views or opinions of InvestingMinds. InvestingMinds did not prepare and does not endorse such content. Please note that this document is intended for general circulation only and the recommendations contained herein do not take into account the specific investment objectives, financial situation or particular needs of any particular person. This document is for information purposes only and it should not be regarded as an offer to sell or as a solicitation of an offer to buy securities or other financial instruments. No part of this document may be reproduced in any manner without the written permission of InvestingMinds.

INTRODUCTION

The investor who wishes to make a serious effort to manage his/her own financial investments faces a formidable task. Virtually all professional investment managers follow a continual process that involves collecting relevant data and then analyzing it to produce decisions on how to act. Both the data used and the methods of making decisions vary widely, but it is not our purpose here to describe the details of either area. Rather, this article concentrates on helping the reader locate free sources of information on investment decision-making processes that she might be able to employ in managing her own investments.

We divide the sources into three areas to be discussed in turn, but of course there are other sources.

ACADEMIC SOURCES

The management of financial investments for the benefit of others is a big business, to say the least. Each year investment professionals in the US collect hundreds of billions of dollars from their clients in fees, commissions, expenses etc. It is therefore not surprising that universities have devoted a lot of resources to business schools and departments of economics where faculty and students spend their time trying to understand how financial markets work, and more particularly how to profitably invest in these markets. Many of the students proceed to high-paying jobs in the investment industry, so that the universities can charge the students high fees. Many of the faculty gain by acting as consultants to financial institutions, and some of them are involved as principals of investment management firms. [see this article.]

It seems to be a situation where everybody concerned should be happy, except perhaps the clients.

The typical individual investor is an outsider to the above structure, but nevertheless there are opportunities for him to gain some benefit from the work that is produced. To an extent, the academic world follows the dictum of “publish or perish”. An academic gains prestige, salary, etc. on the basis of the length (and to a lesser extent the perceived quality) of her publication list. In every academic discipline there are journals that publish accounts of the research performed by people in the field. The shelves of university libraries buckle with the weight of years of volumes of each journal. For example, in 2006, the Journal of Finance, a leading publication in Financial Economics, published over 2500 pages.

In recent years the journals in many fields have been made available in electronic form, but only to those people affiliated with institutions that pay a fee to the body that publishes the journal. For the individual investor who is not lucky enough to have a connection to a university that includes electronic journal access, it may still be possible to obtain copies of some articles from the web sites of the authors, or perhaps by a general search of the Internet. Sometimes a friend might send the investor a copy of a specific article. Of course, for those near enough to travel to a university, it may be possible to obtain hard copies of articles from the library, even if the investor has no affiliation with the institution.

The first few interesting articles that an investor finds can be the start of an endless chain of others. Each article contains a list of references to other articles on related topics. In addition, for those with access to the ISI Web of Knowledge, it is possible to find a list of later articles that refer to a specific earlier paper. For those without this access, a standard search engine can partially take its place.

Some of many web sites of academics are:

• J. Campbell
• K. Daniel
• F. Diebold
• E. Fama
• H. Hong
• A. Lo
• R. Shiller

WORKING PAPERS

It may take several years from submission of the article to the journal to the time when it appears in the journal. Many academics produce drafts of articles, called working papers in the social sciences, that are freely available on their web sites long before the final version appears in print. With experience an investor may learn the names of academics whose articles are of interest, so that he can look at their web sites from time to time and keep up to date with recent developments. This process has been facilitated by the establishment of data banks of working papers, where authors may have their works listed and available for search and download, all at no cost. Note that these data banks do not require that the paper be evaluated by an expert in the field, as is the case with journals. There may be problems with the quality of some working papers, but the journals’ peer review system also has difficulties.

An important data bank in the social sciences is the Social Science Research Network (SSRN) - the section on financial economics will be the one for the investor to look for. The paper with the most downloads is “Market Efficiency, Long-Term Returns, and Behavioral Finance,” by Eugene Fama of the University of Chicago - Graduate School of Business. It was posted to the database on April 30, 1997, and it was also published in the Journal of Financial Economics in 1998. There have been over 60,000 downloads of this paper from SSRN, a staggering figure. Currently the two most popular recent working papers are

“We Don’t Quite Know What We are Talking About When We Talk About Volatility,” by Daniel G. Goldstein, Nassim Nicholas Taleb, London Business School, University of Massachusetts at Amherst,

“Where do Alphas Come From?: A New Measure of the Value of Active Investment Management”, by Andrew W. Lo, Massachusetts Institute of Technology (MIT) - Sloan School of Management,

Another working paper data bank is RePEc (Research Papers in Economics).

INVESTMENT PROFESSIONALS

Professionals such as portfolio managers and consultants probably have less incentive to disclose their ideas to the public, but some professionals have web sites containing interesting information. A small selection is

AlphaSimplex Group Founded by Lo and others

Arrowstreet Capital Founded by Campbell and others

Barra Leading supplier of risk management software - 300 articles available

Burns Statistics

E. Derman

Dimensional Fund Advisors Founded by Fama and others

Goldman Sachs

Haugen Custom Financial Systems

Northfield Information Services

Panagora Asset Management

COMMENTS

Inclusion of a site in the above lists does not imply a guarantee that everything on the site is correct. In particular I and others have reservations about Fama’s ideas on the Efficient Market Hypothesis, and the Fama/French three-factor mode, the basis for DFA’s approach, has been criticized by Daniel.

The topics covered by the sites listed may have a bias towards the quantitative approach. A reader interested in other topics could look through the areas of expertise of faculty at institutions such as those appearing in the academic websites, to find something more to his taste.

For the novice investor, or the newly initiated to the field of investment, there exists numerous “how-to” books and web sites dedicated to informing the new investor and assisting him in understanding the arcane language of the investment profession and financial market practitioner. The InvestingMinds’ “Books” section contains titles of books that can help familiarize the uninformed or novice investor to the ways of the financial markets, Wall Street and investing. The “Financial Encyclopedia” can help with finding the meaning of financial concepts and investment terminology.

The concepts and jargon in academic articles may be unfamiliar to some individual investors. The serious investor might think it worthwhile to spend some time educating herself with the aim of eventually understanding enough to make value judgments of the material. It is wise to question everything you read in connection with investing. A knowledge of the relevant mathematics is valuable. I am dubious about applications of probability theory contained in many articles, implicitly or explicitly, and some understanding of this tricky subject would be helpful.

From experience I know that self-education about investing is possible, and I encourage others to learn as much as they can. These days the Internet makes it much easier to learn about almost any topic.

Breaking with tradition, I’ll give you the moral of the story first: “Slow and steady wins the race”. Like you didn’t know that? But do you really understand it? The Greeks were pretty sophisticated mathematicians so it’s entirely possible that the concept of compound interest was already well understood when “The Tortoise and The Hare” was written. However, had they been sophisticated marketers the famous Aesop’s fable would have been converted into a 60 second spot for the local bank because it serves as a great example of how perseverance and responsible behavior really pay off when it comes to investing. And apparently we all need a 60 second spot like this to remind us of something that, at one level, is intuitively obvious.

I guess I needed to be reminded as well. Despite my quantitative background and the fact that I know all the formulas for calculating compounding it wasn’t until I read a Wall Street Journal article a couple of years ago that I finally put two and two together and realized the simple implication of compounding for investors: Start saving early.

Since a picture is worth a thousand words let’s do a simple example involving twin brothers Tory and Harry. Tory is the responsible one that starts an IRA at the age of 22, squirreling away $2,000 per year while Harry waits 10 years, figuring that he will quickly catch up to his brother by saving $4,000 per year. After all, it can’t be that hard to catch up to someone who only has a $20,000 lead, right?

So, to make the calculations easy let’s assume that the savings are invested at the beginning of each year and return 10% each year - reasonable assumptions. Here are the results over Tory and Harry’s lifetime:

Guess what? Harry never catches up - and for a simple reason. The income that Tory earns on his $20,000 head start exceeds the extra $2,000 that Harry is saving each year in perpetuity. By the time they both reach 65 Tory’s nest egg has grown to $1,435,810 while Harry’s account is a paltry $1,080,097. In fact, if Harry wants to have even a prayer of catching up he needs to start no later than 7 years after his twin brother. It’s no wonder that Albert Einstein referred to compound interest as “the greatest mathematical discovery of all time”.

I was lucky in that I instinctively saved everything I could from an early age despite not fully appreciating what I was doing. But suppose you have followed Harry’s strategy for most of your life and now you’re looking at this example and you’re thinking it’s too late? Well, you can’t do anything about the past but every minute that goes by without a mid-course correction is another minute wasted. Start saving as much as possible right now! You can start by cutting back on the Starbucks. That has to be worth at least $1,000 per year.

The opinions and views expressed in this document do not necessarily reflect the views or opinions of InvestingMinds. InvestingMinds did not prepare and does not endorse such content. Please note that this document is intended for general circulation only and the recommendations contained herein do not take into account the specific investment objectives, financial situation or particular needs of any particular person. This document is for information purposes only and it should not be regarded as an offer to sell or as a solicitation of an offer to buy securities or other financial instruments. No part of this document may be reproduced in any manner without the written permission of InvestingMinds.