Here’s a calculator to explain why Cramer always stays invested
In his Sunday column this week, Jim Cramer noted that this market is facing several headwinds — both at home and abroad. So many, in fact, that he was having a hard time making a case for owning stocks, at least for now. And yet, Jim won’t skip his monthly contribution to his S & P 500 index fund and go to cash. “I invest knowing that, as crazy as it has been, I have made a lot of money with stocks,” Jim wrote. “And as crazy as it might be, I believe I can do so again.” The reason it works comes down to two words: Compound interest. Small, consistent gains over time, compounded through regular contributions, can supercharge your wealth. It’s all about time spent in the market, not about trying to time it. Here’s an example: Start with a balance of 0. Make a $100 contribution to your 401(k) plan or an index fund at the end of every month. Use a 40-year investment horizon; that’s most of a person’s working life. Assume a 10% per year rate of return (compounded annually), roughly the gain for the S & P 500 over the past three decades, before accounting for inflation. Over the 40-year period, or 480 months, you would have invested $48,000. However, thanks to the power of compounding, you would actually have over $555,000 sitting in your account. Compounding starts slowly before it really ramps up as the percentage gains are realized on increasingly large numbers. Thus, the term compounding refers to the most recent gain compounding on top of all the gains that came before it. That’s why it’s so important to start young. The earlier you start, the more time you have to realize the power of compounding. That’s especially true when it comes to retirement planning. Note how the blue bars increase at a constant pace over the years. That is simply the principal you’ve put in — $100 per month or $1,200 per year, consistently. The green bars, however, are where the real money is made: that’s the interest you generate each year, and we see those bars, stacked on top of the principal, growing larger and larger each year at an exponential rate. The reason it works this way is that every time an interest payment comes due, it is paid from a large base. Imagine we have $100 invested at 10% per year (no additional payments). In the first year, we would generate $10 (10% of $100), leaving us with $110 at the end of the year, a $10 increase. In the second year, we generate another 10%, this time on the $110 we have sitting there. That adds $11 to the account (10% of $110), bringing our new total to $121 by the end of year two. The third year would be 10% of $121, or $12.10. As you can see, each year the interest payment grows slightly. Over time, that growth becomes massive, especially when you’re adding money to the account along the way. Understanding and harnessing the power of compound interest is the key to financial freedom. This is not financial wizardry, nor does it require huge returns. It simply requires a disciplined savings plan, consistent investing, and trust in the process. That’s just one scenario. Go back up and put your own numbers in the tool . Maybe you have a shorter time horizon to retirement. Maybe you are more conservative in your investment style and figure on a lower rate of return. CNBC’s data and visualization team has created this investment growth calculator. All you have to do is provide four key assumptions: starting account value, monthly payment amount, assumed average annual rate of return, and investment horizon in years. The calculator does the rest, showing you how much money you’ve actually contributed (principal) and what the power of compounding can do to it over time (interest). (See here for a full list of the stocks in Jim Cramer’s Charitable Trust.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.
