Monday, July 28, 2008

Compound Your Prospects for Success

Thank you for the many positive responses and great feedback on my first blog entries! There have already been several requests for advice on getting gigs and promoting independent music. I do intend to touch on these topics in future posts, but for now may I suggest checking out a new book on that subject by my friend and successful independent artist, Chris Juergensen. For now, my highest priority is conveying the importance of getting started now with your financial plan.

My father was never the longwinded lecturing type, but when I was in college, he handed me a short booklet explaining basic principles of good personal finance, telling me "I wish someone had given me this advice when I was your age". I took the advice to heart, and 20 years later, I'm really glad that I did. The booklet is unfortunately no longer in print, but I found a scanned copy of it online. Some of the numbers are out of date, but the essential principles are still the same.

What did I learn from this book? Most importantly, I learned that starting early with a savings plan will almost certainly make life much easier later on. The main reason for this is the way that compound interest works. I can see your eyes starting to glaze over already. Boring? It's actually quite exciting once you see how the money stacks up.

When you invest over time, the growth of your money is compounded by earning interest not only on your initial investment, but also on the interest you earned in previous years. You earn interest on your interest, and the longer you stay invested, the more dramatic the effect becomes. Here is an updated example based on the booklet mentioned above:

Early Start Musician
Invests the maximum $5000 annual contribution in an IRA (retirement account) at a 9% compound rate of interest for 6 years starting at age 25, then adds nothing more to the account for the next 14 years.

Late Start Musician
Spends $5000 a year on guitar effect pedals and stuff that he doesn't really need for 6 years, then starts investing $5000 every year into the same IRA at 9% for the next 14 years.

Here's how their accounts look with interest accumulated over 20 years:

Age--------------Early Start Musician---------------Late Start Musician
26
---------------------5450----------------------------------------0
27
---------------------11390---------------------------------------0
28
---------------------17866---------------------------------------0
29
---------------------24924---------------------------------------0
30
---------------------32617---------------------------------------0
31
---------------------41002---------------------------------------0
32
---------------------44692---------------------------------------5450
33
---------------------48715---------------------------------------11390
34
---------------------53099---------------------------------------17866
35
---------------------57878---------------------------------------24924
36
---------------------63087---------------------------------------32617
37
---------------------68765---------------------------------------41002
38
---------------------74954---------------------------------------50142
39
---------------------81699---------------------------------------60105
40
---------------------89052---------------------------------------70965
41
---------------------97067---------------------------------------82801
42
---------------------105803--------------------------------------95704
43
---------------------115325--------------------------------------109767
44
---------------------125705--------------------------------------125096
45
---------------------137018--------------------------------------141805

Our "late starter" puts in $70,000 and doesn't even catch up with the "early starter" (who only put in $30,000) until age 45! Now, I don't mean to alarm anybody or label people over age 25 as "too late". On the contrary, I just want to emphasize the importance of starting to invest sooner rather than later. For anybody who is older, the urgency of getting started is even greater, but it's never too late to start.

2 comments:

-CJ said...

This is really important advice for all musicians. Good job Doug!

NE said...

Wow. I am 25, turning 26 in December. I consider myself extremely lucky to have stumbled across this today. Thank you, Doug for sharing your knowledge!