Once you venture into the professional world, you will find that it is not uncommon for companies to reward hard-working and top-performing employees with some type of raise at the end of each year. In fact, according to a Kiplinger’s interview with Sandra McLellan, the North American compensation practice leader for consulting firm Willis Towers Watson, companies are projecting an average raise of 3% in 2017. Further, McLellan pointed out that this is similar to many years past for the average worker, but, employees receiving rates on the high or low ends will see higher than average or lower than average raises. Essentially, the top and bottom ends have become more extreme but the average has not. Thankfully, as an investor, you are likely familiar with the concept of compounding and might realize that even an average yearly raise of 3% can lead to major earnings in the long run. However, if this does not make sense to you yet that is okay! By breaking down the numbers, I can show you how you might be able to turn your raise into a profit machine.
First, it is important to understand that the wealthiest individuals often get there and stay there by making their money work for them. Moreover, this process can be started with just dollars a day and pay off massively over time. For instance, if you were earning $40,352 a year — which is the current median for a 25 to 34-year-olds in the United States according to data from the Bureau of Labor Statistics — a 3% raise would increase your earnings by $1,210.56. On the surface this might not seem like too much money, especially when broken down to $100.88 per month, $25.22 per week and $3.60 per day, all before taxes. However, through the power of compounding I will show you that this is enough money to make a legitimate difference.
For the sake of simplicity, let’s say that the average working adult in the United States between the ages of 25-34 is making an extra $100 per month due to their year-end raise. Additionally, to draw our conclusion, we must use historical data to prove that compounding can drastically change earnings. Now, let’s say that instead of spending the “extra” $100 per month, our sample employee had decided to invest it into an index fund which had an average return of 7% over the span of 25 years. Keep in mind 7% is below the average market return during the past 25 years, but it will further show how impactful compounding can be even if your investments were to be below average. Ultimately, the investment would add up to $30,000 invested and the total value of the investment would stand at $81,211.76. This is more than two full year’s salaries from where the individual would have started — all from taking a little more than $3.00 per day and investing it!
Many investors are aware of the saying, “time in the market is better than timing the market.” However, as pointed out by Seeking Alpha, even well-educated investors tend to forget to apply the saying to their own portfolios regularly. Instead, they attempt to hypothesize where the market is heading and beat it there. Or, regarding our example above, they spend the extra money they receive — such as through a year-end raise — rather than investing it at all. As you now know, though, the longer your money is invested the better the return will generally be. If you can start putting money away at a younger age, you might want to consider doing so. That said, it is never too late to start and even those who are well beyond the 25 to 34-year-old age bracket can benefit from compounding and making their money work for them!