There are two powerful forces that are as essential to finance as gravity is to the universe:
The idea of time is straightforward, but compound interest can be confusing to people who are new to the world of finance and money. Understanding compound interest can exponentially increase the amount of money you earn in the bank, and who doesn?t want that? Let me help you wrap your head around how it works so that you can reap the benefits of compound interest and time.
Two Quick Definitions
If you?re really new, here are a few terms to understand. If you know them, then you can skip to the next header.
The principle is how much money you initially throw in the bank. If I go deposit $5,000, then my principle is $5,000.
Interest is how much money you earn from your principle. Interest is always written as a percentage. That percentage is how much more money I get at the end of a certain amount of time from having my principle sit in the bank. For example, if I earn 10% interest per year on my $5,000, then I get another $500 at the end of the year.
So far, we?ve put $5,000 in the bank and earned $500 in interest, because the interest rate is 10% of the $5,000 we put in. Now we have $5,500 in the bank and all we did was drive to the bank a year ago. That sounds great, so what?s the big deal about compound interest?
Compound interest is interest that you earn on your interest. Let?s keep all the same numbers. You put $5,000 in the bank, earn 10% interest, and after a year you have $5,500 in the bank. If you save that money for one more year with a compound interest rate of 10%, you?ll get 10% on your initial $5,000 PLUS 10% on your $500 interest earnings. That?s another $500 from your principle and an extra $50 from your interest.
I can already see the comments saying ?That?s it? The 8th wonder of the world is worth 50 bucks?? After one year, yeah, it?s only $50. But after 40 years, you?ll have $226,296.28 without touching your money once.
That means if you?re 25 and you put $5,000 in the bank, you don’t put in a penny more, and that money grows at 10% compound interest, you?ll have $226,296.28 waiting for you in your retirement account at 65.
If you?re 20 and you wait until you?re 65, you?ll have $364,452.42. Compound interest?s real value comes with time.
Compound Interest?s Best Friend: Time
Here?s how we jumped from $5,000 to over $200,000. After one year at 10% interest, you get your $5,500. Another year goes by and you earn another $500 from your principle and $50 on that interest.
One more year goes by, and you not only earn $500 from the 10% on your principle, but you also earn $55 from the 10% of your principle interest and 10% of the $50 in interest you earned the year before. Every year, your interest compounds itself and grows year after year. There?s a great online calculator that does all of this for you. So now you?re probably wondering?
How does this work in real life?
A 10% interest rate is great for calculating easy numbers for an article I?ll spend 90 minutes writing, but a real bank will only give you a compound interest rate between 0.1-1.05% per year.?To get the high earnings over time, you have to add money to your account every month. When you do that, both your interest payments and your principle increase. Just adding 10% of your check to your account?every month can have a huge impact on your savings in the future.
Let?s say you get the low end of the stick and get a .1% compound interest rate. If you put $5,000 in the bank and put $300 in that account every month for 40 years, You?ll end up with $152,047.85 in the bank just in time for your retirement account to open. Start earlier and wait 45 years, and you?ll have $170,845.65. That?s almost $19,000 more than the other guy who started saving just five years later.
But you don’t have to settle for 0.1-1.05% in a savings or checking account. You can earn a lot more if you start investing. Investing carries more risk (the value could go up or down in any given year) but your returns could be a lot higher. On average, the S&P 500 has returned 7% since its inception in 1928. The S&P 500 is a broad market index that gives you a high level picture of how the stock market is doing.
The next time you think about buying that $70 hoodie, think about what $70 would be worth in 40 years. At 10% annual interest rate, it’s?$3,168.
In this article, I assumed that you have a retirement account that you?re putting money into and I made it sound like giving up 10% of your monthly check is easy. I know that neither of those things are true for everyone. What you should take away from this anyway is:
Small savings over time can make a big impact
Time is your friend
Young people have one advantage our parents and grandparents don?t have: time. If you start saving early, you will thank yourself when you reach retirement and have that extra cash waiting for you.
Open a separate savings account and checking account. These accounts are low risk since the interest is pretty much guaranteed. But the interest is low. Even the ones that advertise “high interest” are only high when compared to other savings and checking accounts. Open a separate account anyway. Getting 1% on checking will help your money counteract inflation and gives you a separate bucket of money that you can grow over time (instead of spending it).
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On October 19th, 2017, Gitterman Wealth Management hosted?the NYC Sustainable ESG Investing Conference for Financial Advisors?in mid-town Manhattan.? One of the largest conferences of its kind for financial advisors in NYC brought together over 200 financial professionals to talk about the future of Sustainable, Impact, and ESG (Environmental, Social, and Governance) Investing.
Below is a transcript of a talk given by Gitterman Wealth Management Co-Founding Partner, Jeff Gitterman, to begin the day:
Investing With Purpose
Jeff Gitterman: One of the things I wanted to do was level set the differences between ESG (Environmental, Social, and Governance), SRI (Socially Responsible Investing) and Impact Investing, and more importantly, also talk about how we can educate the advisory and RIA communities as to what these endeavors are and why they are so important.
Unfortunately, there are a lot of negative perceptions that remain about Socially Responsible Investing (SRI), because in the past, many advisors have believed, and in some cases rightfully so, that in order to invest in socially responsible ways, there needed to be a sacrifice on returns. What many advisors don?t yet know, is that largely due to the proliferation of computerized big data and artificial intelligence (AI), the landscape of sustainable investing is changing dramatically, and the idea that we need to sacrifice returns in order to invest in this way is no longer true.
As you can see, ESG Investing is at the base of the pyramid.? In our firm, we refer to ESG as the ?GPS of Investing,? in that we see many similarities between ESG data and a car?s GPS system.? Twenty-five or thirty years ago, if we wanted to take a road trip, we would likely take out a large fold-out map to chart our course.? And although this map might tell us how to get from A to B, it would tell us nothing about any potential delays or pitfalls we might encounter along the way ? things like traffic delays or construction roadblocks, etc.
When I first began thinking about ESG, I was walking to work one day, and in my mind, I saw a GPS system. What does a GPS system do? It allows for information, accumulated through computerized big data and artificial intelligence (AI), to come into our car or handheld device, and help us navigate the trip we?re taking, alerting us about traffic and road conditions while providing us with live feed information to reroute us when necessary.
ESG is a similar type of data set, allowing us to think about companies far more in real time than the 10K financial statements do.? I think about the 10Ks as the old fold-out maps, and I look at all this new ESG data that is coming in as the GPS on the companies that I?m looking to invest in.
ESG gives us real-time information from all over the world, about environmental, social, and corporate governance problems that companies are facing. It is a risk mitigator and alpha generator, which are topics that we will talk about in much more depth on?today?s panels. ESG makes it easier for us to achieve our investment goals safely, by giving us all of this live data on a regular basis. It is simply a data set and the foundation of a good portfolio because it helps avoid the potential pitfalls and hazards of intangible asset risk, and will also allow us to vote with our money in ways that we cannot yet even imagine.
Socially Responsible Investing
This brings us to next layer of the pyramid?SRI, or values-based investing. Above ESG, we can incorporate?SRI?screens into our process, where we can layer in a values-based approach with our clients by filtering out certain stocks or complete sectors.? Examples of SRI screens include fossil fuel, firearms, tobacco, and many others.? SRI can also be used to drive investment themes such as climate change, access to clean water, gender equality, etc.?To be clear, SRI screens can be layered on top of ESG screens, but they are not the same thing at all.
There is a beautiful movie out by?well.org, whom we now work with, titled ?Prosperity,? and in it, they point out that if the entire world stopped chewing gum for about a month or so, the whole chewing gum industry would be completely wiped out.
Now, I personally like chewing gum and am not advocating this, but it is a great example of the power that we have as consumers and investors. We need to take away this top-down approach that we?ve all bought into, thinking that the only way to change a corporation is to get on its board and make changes from the top.
I am totally in favor of proxy voting because that is a bottom-up approach, but where and how we spend our money is even more powerful.
Our research shows that 83% of millennials and 77% of women want values based investing, and they will be the ones to turn this pyramid upside down.
At the very top of the pyramid, we have Impact Investing, which we define as an investment into a company with the intention of generating a measurable environmental and/or social impact alongside a financial return.
When talking about companies with regard to Impact Investing, the first question we ask is if they are willing to have themselves measured against a standard, such as the United Nations??Sustainable Development Goals?(STGs), or the?Principles for Responsible Investment?(PRI). Are they reporting on a regular basis, and willing to report to their shareholders on how they are affecting the SDGs and mitigating problems?? This is Impact Investing.
We offer ESG, SRI, and Impact Investing for our clients, as well as research, education, and investing services for financial advisors outside of our firm. But even with clients that don?t have a values tilt; I still incorporate ESG data into their portfolios.? Because again, why would we use an old map when we have all of this GPS data at our disposal? As financial advisors, I feel it is our fiduciary responsibility to at least look at the data.? We have to look at it.
As advisors, I think we?ve gone way too long allowing Wall Street to tell us what products we should be selling to our clients. We are stewards of our clients? wealth, and we can turn the tide. I know that I got into this business to help people, and I think this is true for most advisors. I?m not saying that making money isn?t a big part of the equation, but somewhere at the base of being a financial advisor or RIA is a desire to help people achieve their goals.
Incorporating ?planet? into ?people? and ?profit? is important, because obviously if there is no planet left, there will be no people or profits.? As RIAs, we control most of the mass affluent wealth in this country, and we can make a huge impact.? We can change the world. I truly believe that, and it makes it more exciting to wake up and go to work.
So, I implore all of us to learn more about this new frontier of investing. All of the?companies that are here today?do an incredible job in helping to educate others, and we are speaking all over the country, with many of these companies, helping to educate advisors and investors on how they can vote with their investor capital.
Investing for retirement is something that every person should be thinking about. While it might not be easy to save due to low wages and/or high bills, the ability to put something aside for retirement is one of the most important things we can do to secure our future. There are many options available for people who want to begin investing for their retirement now. Be warned, this blog has a lot of finance jargon but take your time, look up any terms that you don?t already know and by the time you finish you?ll have a much better idea of what goes into investing for retirement.
The investing arena is filled with investors that have different needs. But one constant is the desire to provide for themselves or their families financially after retirement. Creating ongoing financial returns from investments can help create a stream of income for retirees. It is a means of securing financial freedom while no longer being in the workforce. While certain strategies might be used widely in finance, they might not be suitable for a person that is trying to gain a retirement level of income. Knowing what different options are available and why different people choose them is a great place to start ensuring the investment you choose for your retirement fits your needs.
How to Invest for Retirement
The first step in determining a strategy to investing is to figure out where you are in the process. If you are younger, you have more time to take higher risks in your investment portfolio. This is only because you still have the time to recoup any loss if an investment doesn?t work out. You also have more time to take advantage of compound interest growth. The older you get, the less time you have to recoup losses or change course, and therefore the less risk you want to see in your investment portfolio.
The most important aspect is to set aside a portion of every wage or income stream for retirement purposes every month. You’ve heard of “pay yourself first”. This is very important. No matter what else is going on your life, find a way to set aside something (even as little as $50 per month) for your retirement. The amount you can contribute will be determined by income and expenses.?In general, a good rule of thumb is to save 15% of your income every year, starting at 25. But even 5-10% will create a noticeable benefit, especially if you have time on your side.
Another rule of thumb: by age 30, the goal is to have 1x your income saved for retirement and invested stocks and bonds. By age 40, it is 3x your salary saved. By 50, it jumps to 6x. And by 60, you’d be looking at having 8x your salary saved and invested for retirement.
Why Tax Deferred Accounts Are Good
Most retirement accounts are tax deferred accounts. Why are tax deferred accounts good? Two reasons:
If you put money into a tax deferred retirement account like a 401k or IRA, that money grows tax free until you take it out.?When you withdraw the money, the investment gains made on that money will be taxed at your then current tax rate. That means that if your tax rate is lower in retirement (it usually is) v. your current tax rate, it makes sense to defer paying taxes on those gains until later in life.
When you move some of your income into a tax deferred retirement account, it lowers your overall adjusted gross income (AGI) in that year. That means you will pay lower taxes on the rest of your income that year.
Consideration must be given as to whether you are self-employed or have access to a pension pot and/or also can contribute into a voluntary contribution scheme,?like a 401k.
If you work for a company and they offer a 401k plan, find out if the company matches contributions into your 401k. Many companies encourage their employees to save for retirement via the 401k program by matching up to a certain percentage of your salary. For example, 3%. But it’s called a match for a reason. It means you need to put in at least 3% of your income into the 401k retirement account in order to get their 3% match. We cannot underscore this enough: make sure to max out your 401k contributions each year. If you cannot, then at least put in up to the company match. Why? Because it is free money. The company is literally offering to match your contributions for retirement. That’s separate from your salary, bonus or equity. In other words, don’t leave free money on the table.
Individual Retirement Accounts (IRAs) are also popular for retirement investment. There two types of IRAs: Traditional IRA and Roth IRA. Both have a $5,500 contribution limit per year for 2018. Here we will provide a quick overview of the Traditional IRA. IRAs? are available to both self employed and company employees.?Like 401ks, Traditional IRAs have the benefit of being tax deferred for amounts up to a certain level per year, which makes them doubly advantageous.
There is also no limit to how long an investment can grow in these accounts past the age of retirement, there is a requirement to start withdrawing money by 70.5. With upfront tax deductions available as well as the tax credit deferral, the Traditional IRA is another good choice for retirement investing.
If you are self-employed there are other retirement contribution schemes available. These include a SEP IRA, i401k (Individual 401K) or Simple IRA. We will profile the SEP IRA in this section.
SEP stands for Simplified Employee Pension. With a SEP IRA, your business (not the individual) funds the account. Any small business owner with one or more employees, or a freelancer can set up a SEP Account. One of the main advantages of a SEP IRA over Traditional or Roth IRAs: your contribution limits are much higher. In 2018, the contribution limit is $58,000. That means that you can put in up to $58K in tax deferred income every year. And it doesn’t have to be the same amount every year. In a lean year, you can put in a much smaller amount. In a great year, you can load up and defer a significant amount in tax payment.
Guaranteed income annuities, cash value life insurance plans, non-qualified deferred contribution plans and real estate investing all investment vehicles that are set up for investing for retirement. But be careful, some of these products carry many hidden fees. For example, some annuities will charge 50% of your premiums in the first few years as a commission fee for the salesperson. Make sure you fully understand the terms before signing up.
The main factor to remember is to consider what you have at present and how long you have to make a gain or handle a loss. The closer you are to retiring, the less risk you want to take with your investments. High-risk investing is for younger people with the time to recoup their losses in the future. Choosing solid and stable investments later in life will help to create consistent income and see you able to retire when ready, a guarantee not everyone has.
Investing in good companies is a smart money move.
You may not care that 8 million metric tons of plastic are thrown into the ocean each year. Or that the earth is warming at an unprecedented pace.?Even if these metrics don?t hit your radar, it may interest you to know that it now pays good money to be a good steward of the planet and its people. It is possible to make great investment returns with sustainable investing and even outperform other types of investment strategies.
Here’s why it pays to get into sustainable investing.
Sustainable investing is sometimes called Impact Investing. Here are the top reasons to get into these socially responsible investing strategies.
The myth that you have to give up performance for purpose has long since been debunked. If done right, socially responsible investing does not hurt returns. In fact, with the right strategies, the opposite is usually true.
As it turns out, socially responsible funds have been on par or beating the market for decades.?You do not need to sacrifice returns for purpose.?The socially responsible index (MSCI KLD Social Index) has outperformed the broad market index (S&P 500) for over 20 years.?
There isn?t a price to be paid for being good. In fact, the inverse may be true. There is a price to be paid for not investing in good companies. Why?
Investors are always on the look-out for ways to reduce risk.
This is why Environmental, Social, and Governance (ESG) factors are becoming increasingly important in valuing companies. Investors are realizing that these metrics can greatly impact company value, either positively or negatively.?According to Cornerstone Research, intangible assets such as human capital, intellectual property and ?brand? now represent 84% of a company?s market value. ?
That means you as a consumer have more power to pressure companies to do the right thing while capitalizing on your investment.?Voting with your values is no longer simply the right thing to do, it is the smart thing to do.
4 ways to make money with sustainable companies.
You can now outperform the market and invest with purpose. There are several ways to invest in good companies.
1)? Invest in individual companies.
Research and find your own companies with high ESG scores. This is a time-consuming process. It is also high risk because you?re putting all of your eggs in one basket. If the company does well, you win. If the company doesn?t perform, you lose. The risk sits entirely on one company.
Cost is low. The only fee is the commission to execute the trade. You?ll also need to open a brokerage account to place the trade. Robinhood Trading is a newer trading platform that now offers commission-free trades.
Time: Very High
Effort: Very High
Return: Very Low to Very High
2)? Invest in socially responsible mutual funds.
Another option is to invest in a socially responsible mutual fund. There are hundreds of funds in this category. Use this tool to find and compare fund cost and performance.
The biggest issue with mutual funds is their expense. They tend to have a higher expense ratio and higher turnover. ?The expense ratio is the fee that the fund company charges to manage the portfolio. Turnover represents the percent of the fund assets that have been bought and sold that year. The higher the turnover rate of assets in and out of the portfolio, the higher the taxes.
Believe it or not, sometimes mutual funds both underperform and are more expensive than alternatives like ETFs (exchange traded funds). On the other hand, some funds have great thematic strategies for social responsibility investing. The good ones take a fully integrated approach to ESG investing. When the research team is strong, this could create excess returns that make the extra expense worth it. Meaning: do you care about the expense ratio that much if the fund is outperforming their peers? Bottom line: it pays to research. Doing thoughtful research will take some time.
Risk: Low to Medium
3) Invest in socially responsible ETFs.
Exchange Traded Funds, or ETFs, have become all the rage in recent years thanks to their low cost. There are 58 socially responsible ETFs, 23 of them launched this year alone. That number is likely to go up year-over-year. ?Like stocks and mutual funds, it pays to do your research. Make sure you?re not investing in a socially responsible ETF that simply ?ticks the box? of ESG factors. Finding one that is actually making an impact can take some time.
Return: Medium to High
Risk: Low to Medium
4) Invest in impact portfolios.
Robo advisors and impact platforms combine the best of both worlds. You get the thematic approach of mutual funds at a lower cost.?There are several robo advisor platforms out there, including Wealthfront, Betterment, and Wealthsimple. Some have recently introduced social responsibility portfolios. ?
We are also seeing the dawn of socially responsible robo advisors. Motif is a values-driven robo advisor backed by Goldman Sachs. Depending on how you feel about a big bank Wall Street backer, Motif could be an option. You?ll need $300 to start investing.
Another option is Swell Investing. Swell is an impact investing platform backed by Pacific Life. Their focus: deliver profit and purpose. With just $50, you can invest in one or more values-driven portfolios designed to impact our world in positive ways, while producing high growth. We took a good look at Swell here.?Their portfolios include Green Technology, Renewable Energy, Zero Waste, Clean Water, Healthy Living and Disease Eradication.
Return: Medium to High
Start impact investing with Swell
You can start investing with purpose and for profit today with Swell Investing. We did a deep-drive review of??their services. Here’s why we like them:
Anyone can join for $50
Choose from any of their?six impact portfolios, from renewable energy to disease eradication and zero waste
No expense ratio fees or trading fees
Very transparent?and low fee structure (only one)
You own the companies in the portfolios
Very easy to set up?with their user-friendly app and website
Your investments are insured
Your money grows for profit and for good
Get on your way to making a real impact with your investment dollars. Your money matters.?
When we invest with our values, we can grow profit and drive positive global change.
Check out our interview with Swell Investing CEO Dave Fanger and CMO Teresa Orsolini.?Our partner Pedram Shojai from Well.org had a great conversation with the Swell team about investing for growth and impact.
As a beginner in the investment arena, there are so many options that you might have an overload of information. Choosing the right type of investment for your needs is the most important aspect of investment. Helping yourself is central to that, of course, but there are ways that investing can be done to the greater benefit of others as well. Knowing where to find these types of opportunities can transition you from a mere investor to one that has an environmental and social impact, a conscious investor wielding capital for profit and progress.
It is a good idea to figure out how much money you have to invest, whether or not you could afford to lose it or not, and how long it would take you to recoup that investment stake should any investment not pan out. Younger people have more time to make mistakes in investing and therefore can consider riskier investments with more ease than an older investor would. Socially responsible investing is something that can be done to ensure there is a positive impact from your investment. This would include companies that promote diversity, consumer protection, human rights or environmental stewardship.
One of the best way to invest is through sustainable investing; ensuring that you receive a dividend on your investment while knowing that your money is being put to a good use. A great example of this is the microloan or microfinance. There are a number of websites that can put an ethical investor in touch with a person that needs a loan to give their family a chance at a sustainable life. Microloans can be used by people in developing parts of the world to buy stock of some kind, perhaps animals for a farm or raw materials to make products to sell from. The investment will benefit the individual and the investor alike.
Also, an investment that acts to improve the local community or the environment can bring both purpose and profit. Whenever possible, investing in either the local area or in an area of need is a wonderful way to use your voice as a consumer and investor, while ensuring that you will have a stable chance at an ongoing dividend and gain on your initial investment.
Make small investments and spread the amount you have to invest in several diverse types of investments, thereby creating a diversified portfolio. This way, if one investment suffers, the others will help to keep the dividends or gains coming in and you won?t lose all your investment in one swoop.
?Investments to Avoid
For an environmentally and socially conscious person, there is more to an investment than simply making a return. If you want to help the world at the same time, avoid investments in the gun industry, fossil fuels, alcohol or tobacco or many raw materials including diamond mining or another type of physical mining of raw materials in underdeveloped countries. Any investment that has the knock-on impact of creating a negative situation for someone else or somewhere else is not a good investment. Any industry that historically causes environmental damage is one to avoid, as well as any that have shown they do not care about the human rights of the people where they take their materials from.
The reason that investments exist at all is that there is always a need by companies to gain funding to further more projects. They sell the desirability of owning stock in their company by ensuring a good dividend or return is paid out ongoing. Even the most corporate of businesses act on this premise. It is not charity to invest in areas which can be shown to be of benefit to other people, it is just a sustainable investing option that helps others as well as you. Knowing what type of investment that can make an impact while delivering the safety and an expected dividend an investor requires is easy to do.
All investing should be done after a great deal of research, no matter what the investment is in. Taking all factors into consideration and weighing up the benefits and cost of the investment with the resulting use of the investment by others while result in a socially conscious investor. The best way of furthering positive activity globally while doing our own parts in reducing the harm that is done is by not helping the harmful companies do more harm. Being sure that your investment does not harm the workers of the company who will be producing the product you invest in is one aspect, as is making sure that the investment does not harm your neighbors and those around you.