I won't blame you if you think this is hyperbole -- these days, a trip to the grocery store for a family of four can run as much as $150 per week. Saving as little as $100 per month can feel like trying to extinguish a fire by filling up a thimble with water.
But there's a reason Einstein reportedly said that the greatest force in the universe was compound interest: given enough time -- and tended to regularly -- even the smallest amounts can accumulate to make life-changing differences.
How much can $100 per month really grow to be?
Here's where most articles will take the average return of the stock market -- between 9% and 10% per year -- and simply use that to show you how your money will make a straight line up over time.
While that's good for illustrative purposes, I'd like to show you exactly how your money would have grown over a real period of time.
Let's say that in January 1970 you started putting away an inflation-adjusted equivalent of $100 per month. We make it "inflation-adjusted" because $100 back then was a lot of money -- equivalent to $660 today -- and you invested that lump sum in the broader stock market (we'll get to how to do that below). Here's how that sum would have grown over time.
By the end of 2017, this simple investing strategy would yield a nest-egg of over $180,000. While that's nowhere near an amount that you can retire on alone, it would put you in the upper-eschelon of retirement accounts.
To put the importance of time in perspective, here's how much would be sitting in your nest egg if you started investing $100 -- adjusted for inflation -- over different time frames.
|If you started investing (inflation adjusted) $100...||Then your nest egg would have...|
|45 years ago (1972)||$175,100|
|40 years ago (1977)||$150,600|
|35 years ago (1982)||$114,500|
|30 years ago (1987)||$80,400|
|25 years ago (1992)||$57,400|
|20 years ago (1997)||$40,500|
|15 years ago (2002)||$32,000|
|10 years ago (2007)||$21,400|
|5 years ago (2012)||$9,300|
Of course, saving and investing more than $100 would be nice -- but this isn't chump change either! Following the 4% safe withdrawal rule, a nest egg of $180,000 could provide $7,200 in annual income. When combined with Social Security, any pensions or other retirement plans, and part-time work, this could provide enough for you to call it quits on your day job.
The power of compounding
The real key behind all of this is the power of compounding. Simply put, this is means that you will get interest on your original investment. And then you'll get interest from your interest, and so on.
After adjusting for inflation, the stock market returns about 7% per year. That means the $1,200 you invest in year one will be worth $84 more in year two. When year three rolls around, that original sum will gain even more -- roughly $90 -- because the interest from the previous year will grow as well. That might seem like small stuff, but over time, the effects can be astounding.
Here's how much money you'd have, in constant dollars, if you start putting away $100 every month and earn a steady (note: it won't be steady in the short-run) 7% every year.
For the first twenty years, the effects of compounding aren't all that impressive. But after that, the growth from your original investments is what becomes the true driver of wealth. By the time 50 years have past, you've contributed $60,000 inflation-adjusted dollars to your nest egg, but the effects of compounding have added another $462,000 to boot!
Am I ready to invest $100 per month?
No matter your age, however, there are a few boxes that need to be checked off before you're officially ready to start investing $100 per month. Specifically, you need to build up an emergency fund to provide for your basic expenses for at least three months with no income, and you need to pay off all high interest -- namely credit card -- debt. Failure to do either will only dig a deeper hole to climb out of.
Consider credit cards. Currently, the average interest rate on an unpaid credit card balance is above 16%. That means that the $1,000 balance you have yet to pay off will total $1,160 by next year if nothing is done. Crucially, the stock market -- on average -- returns 10.8% per year. That means even though your $1,000 investment could grow to $1,108 by next year, your debts will have increased at a faster clip!
While it's not mathematically the most efficient way to rid yourself of credit card debt, Dave Ramsey's debt snowball method has proven especially effective. The idea is that you pay down your smallest credit card balance first, and work your way up to the largest one. The psychological benefits from crossing each balance off your list give you the strength to carry through.
As for the emergency savings, it's crucial to understand how it will protect your investments. Most times, people need "emergency" money because they've lost their job. And most times, lots of people lose their jobs around the same time as economic contractions hit. And most times -- are you noticing a theme here? -- economic contractions happen at the same time the stock market tanks.
Think about it: if you have to tap your investments to pay rent or buy food, you'll be forced to sell stocks when they are at their lows. And when those stocks recover, you will no longer be participating in their rally. If, however, you have an emergency fund, you give yourself time to find other sources of income without having to panic-sell.
Where can I set up my account?
Next, we need to cover the nuts and bolts of actually setting up an investment account. Because you'll be investing $100 per month, you want to lower your transaction costs as much as possible. You can do this two ways: either go with the lowest cost-per-trade discount brokerage out there, or wait to buy stocks once every two or three months.
Ultra-low-cost brokerages like Robinhood allow you to make trades at absolutely no costs. There are, however, some restrictions in terms of what you can buy using that platform.
I, on the other hand, use Ally Financial (NYSE:ALLY) to buy stocks. The online firm charges $4.95 per trade. If I purchased one stock or fund every month with $100, trading costs would eat up 4.95% of my cash -- a pretty hefty percentage. If, on the other hand, I only made purchases once every three months -- with a total of $300 each time -- the trading costs would deplete 1.65% of my funds.
We have our own Fool.com broker center set up with options that offer special deals to peruse as well. In the end, it's worth visiting each site to determine which platform you feel the most comfortable using on a regular basis.
What kind of account should I open?
Once you pick a brokerage account, you're ready to sign up. As you go through the process of filling out the (likely virtual) paperwork, you'll be asked what type of account you'd like to open. I highly suggest you consider making this a tax-advantaged retirement account.
The two most common retirement accounts are Traditional IRAs and Roth IRAs. Between the two of them, you are allowed to put away up to $5,500 per year ($6,500 if you are 50 or older), but that shouldn't be a concern since right now you're just shooting for $100 per month.
Money you put into a Traditional IRA is tax-deductible immediately, meaning the $1,200 you put in over the course of a year will lower your income taxes right now. When you pull the money out in retirement, you'll have to pay taxes then -- though most people's tax brackets are lower in retirement than during their working years. It should be noted, as well, that there's a 10% penalty for withdrawing money before you reach 59-and-a-half years old.
With Roth IRAs, you get no immediate tax benefit. All of the growth and all of your withdrawals in retirement, however, are completely tax free. As a bonus, you can take your principle out at any time without having to pay a penalty. If you withdraw more than that amount -- if you pull out some of the growth your Roth has accumulated -- you will pay a 10% penalty.
Whichever you choose to use, it's wise to put your money in these tax-advantaged vehicles to cut down on the amount you have to pay Uncle Sam over time.
What to invest in
There are as many investing styles in the world as there are investors. That being said, we can cover most investing styles with some broad strokes. In the most general sense, it all comes down to your goals.
- Growth investing is when you buy shares of a stock or fund because you believe the overall price will continue upward with uncapped potential.
- Value investing is also done because you think the price of a stock (or fund) will continue to grow, but only to a certain, predetermined point.
- Income investing focuses more on the quarterly dividend payment you might receive from owning shares, and isn't as concerned with overall price.
Beyond stocks, you can also choose to invest your money into mutual funds, which tend to have high fees and under-perform the market, or Exchange Traded Funds (ETFs), which have lower fees and tend to match the market's performance.
Since you are likely a beginner looking to get the broadest exposure to stocks, I think your best bet is to put your $100 per month into shares of the Vanguard S&P 500 ETF (NYSEMKT:VOO). By owning shares, you pay a very small 0.04% expense fee per year, have exposure to the 500 largest stocks in the United States, and receive a modest 1.8% dividend yield. The stocks you'll be investing in range from growth stocks like Amazon.com to slow-growing energy companies like Consolidated Edison. This range in investments will also add the safety of diversification to your portfolio: if one stock goes down by a lot, it won't have an outsized effect on your portfolio.
You can always bump up your savings
Anything you can put away now is important. If saving an extra $100 per month seems like a herculean effort, here are some ideas to get the ball rolling:
- Automatically transfer $100 from the account your employer pays you to an investment account. Then you don't even need to think about it.
- Make all of your food at home for a month. You might be surprised by how much you're spending while out on the town.
- Ditch the car and bike or take public transit to work. Use your gas (and maintenance) savings to invest.
- If you are routinely spending $150 per week on groceries like the family of four that started this article, consider only going once per month to wholesalers like Costco.
You are giving your money the gift of more time to compound compared to cash you put away a year -- or a decade -- from now. Should your expenses dwindle or your income grow, however, remember that you can put away far more than $100 per month. By doing so, you give your money more time to grow, and shorten the amount of time you need to wait before being fully financially independent.