Rule of 72

In a previous blog I discussed the power of compounding interest.  But how long does it take until your money doubles?  This is a common question, and should be as the point of investing is to increase the value of your money.  There are calculators you can easily Google which will calculate how long it will take to double/triple the value of your account, but there is an easy way to calculate an estimate.  This is called the Rule of 72.  It is a really easy way to estimate the time required to double your investment.  To perform the calculation, simply take 72 divide it by the interest rate (in percentage) of your return and the answer will be an approximate in the number of years to double your investment.

72 / 9% = 8 years

Remember, this is merely an estimate.  The actual time required to double your investment at 9% is 8.043 years.  Not too far off of an estimate.

Compounding Interest

Looking back to when I was a private, there were several retiring First Sergeants and Sergeants Major who were trying to instill their parting wisdom upon the minds of those who will replace them.  One message they all shared was to save, and start now.  Not being to financially savvy, they talked about starting a Thrift Savings Plan (TSP) as it was a new program Soldiers were allowed to participate in.  As these senior Soldiers were looking toward retirement, they did not want their subordinates to make the same mistake of not taking advantage of compounding interest.

Interest is the profit you can make from investing your money.  Let’s do some simple math to see how this works.  Suppose you have $10,000 to invest and place it into a program yielding 10% interest.  After 1 year you will have made $1,000 in interest, and have a total of $11,000.

$10,000 x %10 = $1,000

So how does compounding interest differ?  Well you aren’t going to stop investing after that one year.  Now on year two we still have our original $10,000 and our earned $1,000, all of which is earning 10%.  Again our $10,000 will bring in another $1,000, and the previous earned $1,000 will bring in $100 for a total account value of $12,100. 

$10,000 x %10 = $1,000
$1,000 x %10 = $100
$10,000 + $1,000 + $1,000 + $100 = $12,100

Why should you start saving now? The longer your money has a chance to grow the more it will work for you.  Let’s imagine you have just completed basic training and there are twenty years ahead of you until you are able to retire from the military.  In our scenario you will be placing $400 a month into a Roth IRA account from now until you retire.  Doing simple math, $400 x 240 months will mean there is $96,000 in your investment account.  But what would all of that money do if it was compounding interest for you?  I am now going to adjust the scenario to earn an average of %10 a year.  After doing some computations, your account would have the $96,000 you contributed plus an additional $207,747 in interest for a total of $303,747. 

But what about your senior leader who is getting ready to retire and has only five years left in the military?  Running those numbers of $400 x 60 months you would only have $24,000 in contributions.  After letting this money compound for the 5 years, the total account value would be $30,974.  That means less than $7,000 interest earned.  Looking at these numbers, you can see why your senior leaders wish they could go back in time to when they were a private and begin saving then.

Earlier I mentioned in our scenario we would be placing this money into a Roth IRA account.  Just because your service in the military has ended doesn’t mean you can start taking deductions from your IRA. Suppose you enlisted into the military at 18 and served 20 years, you would still have another 21.5 years until you are eligible to use money from your IRA.  What would your $303,747 be at that time without any additional contributions?  Using the same interest rate as above, your account would value $2,280,750!  Wow, who would have thought being a Soldier would make you a multimillionaire? Best of all since you were placing these funds into a Roth IRA account it’s also tax free.

Please consult with your accountant for your unique situations.

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Individual Retirement Accounts (IRA)

How would you like to save money and keep Uncle Sam’s hands off of it?  Individual Retirement Accounts (Commonly referred to as IRA) are a great way to plan for the future while sheltering your savings from the tax man.  There are two common types of IRA accounts, the traditional IRA and a Roth IRA.  Both accounts have benefits and there is no simple answer as to which one is best for you. 

A traditional IRA allows for contributions of up to $5,000 a year.  Contributions made to your IRA account are tax deductible.  All earnings made within your IRA account are deferred until you make withdrawals from the account at which time you will pay the taxes on the amount of money withdrawn from the account. 

The Roth IRA also allows for contributions of up to $5,000 a year.  Where the two accounts differ is how the account is taxed.  Roth account contributions are not tax deductible.  But like the traditional IRA, the earnings within a Roth IRA are shielded from taxation.  Additionally, when deductions are made from a Roth IRA, they too are tax free. 

For those of you who are late bloomers on saving for retirement, you are in luck. An additional $1,000 in contributions is authorized for those ages 50 and up.

With both programs offering great benefits, there must be a catch right?  Well the catch is the simple; you can’t touch your money. Well that is until you are 59.5 years old.  I know some of you who were skeptics about IRA’s are now losing interest but please remember it is a retirement program and there are always exceptions to the rule.  Some of these exceptions are purchasing a home, having a disability, medical expenses, and long term unemployment.  If you don’t meet one of these exceptions and need to withdraw money prior to 59.5 years of age, you are still able to do so, but at a price.  You will be taxed on the amount of money you have withdrawn at your tax rate, and incur a 10% fee for the amount withdrawn.

So you have made the decision to start saving for your (and your family’s) future, but don’t know where to start.  The easiest place is to make an account is with your favorite financial institution.  Many investing firms offer both traditional and Roth IRA accounts that are easy to start online.  Each firm offers different rates for trading.

From my personal experience with talking with fellow Soldiers of all ranks, finding $5,000 to contribute to an IRA account is difficult.  The reasons I receive for why they can’t start saving are all too common.  If you are thinking of a reason now, I am sure I have heard it.  But you need to start saving for your future, because no one else is going to.   When I was a junior enlisted Soldier I couldn’t afford $5,000 a year.  Instead I could afford about $100 a month and created an allotment to save automatically.  A few months later I received a promotion, a pay increase of about $50 a month.  So I increased my allotment to reflect my pay raise.  After a few years and several pay raises later, I was able to get my monthly allotment to $400 a month.  You can establish an allotment with MyPay to have the funds sent directly into your IRA account.

Please consult with your accountant for advice unique to your situation.

Saving for Retirement without Living Like a Pauper or Winning the Lottery, Updated and Revised - Amazon.com

Welcome to Military Money Wise

While at work a fellow Soldier noticed I was on an investing website.  He asked me if that was the best place to invest.  I related to him there is no “best” way to invest money as the definition of “best” differs from each individual.  This Soldier went on to state he has saved up $20,000 (I was impressed being he was a married junior enlisted Soldier) but lacked the knowledge of what to do to make his money work for him.  I explained several investment opportunities from traditional investment accounts, Individual Retirement Accounts, Thrift Savings Plan, Peer-to-Peer lending, and purchasing Real Estate.  The aim of this blog is to provide advice to fellow Service Members so they can make educated decisions on topics of investing, debt consolidation, and planning for your future.  If you have any topics you would like me to discuss, feel free to send an email.