Oh, the joys of compounding.
We often hear financial experts say that, if only workers in their 20s would save just $880 a month, they would have a million dollars by the time they retire at age 60, with a constant return of at least 5%. A 45-year-old would have to invest $3,741 a month to save the million dollars by age 60, almost four times as much. So, thanks to compounding, instead of buying that fancy new car or taking an expensive vacation, it pays to put money away for retirement. And keep it there.
In order for compounding to work, one has to reinvest the earnings on an asset. Rather than taking out the dividends you earn on a stock, or the interest earned in a savings account or CD, smart investors reinvest dividends to buy more shares, and the interest on a savings account becomes part of the ever-growing principal.
Richard invests $10,000 in an index fund called Grow Your Money Fast and holds it for 20 years. Since he reinvested all dividends, interest, and capital gains back into the fund, it is now worth $45,000. If he hadn’t reinvested the distributions, the value of his investment would only have been about $30,000. Since Richard held this fund in his retirement account, the savings will grow tax deferred as well.
Related or Semi-related Video
Finance: What is Imputed Interest Rate?1 Views
Finance allah shmoop What is imputed interest rate Imputed guest
at or presumed based on x y and z that's
the foundation of an imputed interest rate and its chief
cheerleader Yep It's the i r s the tax people
those guys you just love to hear from Why Well
because taxes need to be collected Right We have pork
to buy for politicians Come on people Get with it
So we have a zero coupon bond here We bought
for five hundred bucks which comes do or pays off
in ten years for a thousand dollars on lee Remember
Zero coupon bonds don't pay any interest along the way
They just pay a one time end of period amount
which includes interest and principal The irs taxes Bondholders imputed
interest Yes like gains based on whatever interest rate is
imputed by the terms of the deal So in this
case remember that rule of seventy two thing so many
years to doubled about it into seventy two and all
that Yeah So in this case the money takes ten
years to double that's ten into seventy two paying seven
point two percent interest per year Compound it So the
irs would take as an imputed interest Five hundred box
times seven point two which is thirty six dollars of
taxable imputed interest games And they would take that each
year and you'd pay that each year on your taxes
So if you owned this bond and we're living in
a forty percent marginal tax bracket blue state which you
livin bitterly even though you got no cash interest from
this bond will you'd suffer a cash tax hit of
forty percent of thirty six or a bit under fifteen
dollars each year as you went along So that's the
bad news you pay the cash up front The good
news is that when the bond finally came do that
decade later for that grand well you have already paid
the taxes along the way And when taxes are already 00:02:01.504 --> [endTime] paid well we impute you'll be a happier camper
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