The secret power of recurring investments
Recurring investments are a powerful tool
It’s easy to get discouraged by investing. With interest rates hovering at 3-5%, even modest retirement budgets require well over a million dollars in investments to work properly (e.g., $1,000,000 x 3% = only $30,000 per year). Many people get discouraged because they don’t have much saved now, but the truth is that the most important thing in any retirement plan is making repetitive, reliable recurring investments.
Today, I am going to show how powerful recurring investments of even modest amounts can be. I am going to be using Personal Capitals free retirement calculator tool, which I use in real life to catalogue all of my savings and investments to develop a comprehensive view of my retirement plan. The view below shows the build up in my retirement assets (if everything goes according to plan), and then my drawdown starting at the not-quite-FIRE but not-quite-normal retirement age of 53.
Lump sum vs. recurring investments
Before we take a look at the power of recurring investments on their own, I think it’s important to know what a lump sum investment looks like over time when combined with a recurring investment. The reason why I am showing this is that I believe people get way way too caught up in what they CURRENTLY have, and forsake further saving out of frustration. The conversation goes something like this:
“I’m never going to be able to make it to retirement because I am 35 and my IRA only has $20,000 in it. If I had $200k maybe I would be able to meet my goals, but since I don’t there’s no point contributing to my IRA. I might as well keep my contributions now, I need the money anyways.”
My goal is to show how backwards that line of thinking is, and illuminate how powerful recurring investments can be when they are used to your advantage. Recurring investments even have a secret power which I will illustrate at the end.
Recurring investment calculator scenario 1: Lump sum + recurring investment
In this first example, the subject is 32 years old and has $100,000 to invest. They intend to invest the full $100,000 along with $10,000 per year until they retire at 66. The assumption I made in the Personal Capital recurring investment calculator was for a 7% rate of return. To make this simpler, I am not inputting any retirement withdrawals. The view below shows the potential “best case” scenario and “worst case” scenarios in light and dark blue, respectively. You’ll notice the cant of the line changes at 66 when contributions are no longer being made.
As you can see, the best case is around $2m at 66 after 24 years, and $4m at 92. The worst case numbers are approximately half of that. The total contributions for this scenario are the original $100k investment along with $240,000 in contributions over time.
Obviously, this result is great, but you can easily replicate the success of this portfolio without the lump sum in the beginning.
Recurring investment calculator scenario 2: Recurring investment alone
In this second scenario, everything is the same except for 2 variables. First of all, there is no lump sum investment at the beginning. Second, the recurring investment is increased from $10,000 per year to $13,500. Take a look!
Notice anything interesting? That’s right - the best case scenario is now nearing $5m at 92 and $2.5m at 66, about 25% higher than the lump sum in scenario 1. The difference on a month to month basis in contributions is not that significant: in the first scenario the monthly contribution is $822, in the second it is $1125. About $300 more.
The hidden advantage of recurring investments
The craziest part about these two scenarios is total contributions. In the first scenario, the investor contributed $340,000 total over 24 years. ($100k + $10k*24). In the second scenario, the investor contributed $324,000 total over 24 years ($13.5k*24).
Let me say that again. In the second scenario without a lump sum at the beginning, the investor ended up with 20% more money and contributed $16,000 less over time. And they didn’t have to come up with a huge lump sum at the beginning!
You might be asking yourself how that is possible. If you run the calculations I showed you above in Excel, with 7% returns every year going forward, scenario one with the lump sum wins every time. This is where the genius of Personal Capitals free recurring investment calculator comes in: investment returns are not a static number. The stock market varies wildly from year to year, with some years well over 20%, and other years well below -20%. Over a long time, they average out to 7-10% per year. However, right now, after 10 years of economic expansion, the chances of a stock market pullback in the next 5 years are incredibly high.
Personal Capital has included the high likelihood of a stock market pullback in the short term in their model, which is why the “slow and steady” contributions over time are rewarded more than a huge lump sum today. A lump sum is likely to decrease in value over the next 2-4 years. In the investment world, this periodic and recurring investment is called “dollar cost averaging”, with the theory being that there is no way to know when the best time to buy a stock is, so the best action is to buy a little at a time, over time. You’ll definitely buy some at bad times, but you will also guarantee buying at least a little at very very good times.
A recurring investment, in other words.
Conclusion: recurring investments reward repetition, not magnitude
The most important thing to take from this post is the value of recurring investments, even in relatively small amounts. Over time they add up quickly, and smooth out the inevitable ebbs and flows of the stock market.