See if given these circumstances you choose the investment that makes you the most money. Don’t cheat and read ahead. Hypothetically, you inherit $100,000 and you need a short term vehicle to invest your money. You have three options to choose from. Without a lot of thought, which do you pick?
First option, is a 90% gain in year one with a 50% loss in year two.
Second option is a 40% gain in year one and a 40% loss in year two.
Third option is a 4% gain in year one and a 4% gain in year two.
Which option feels like it will give you the best return on your money in the first two years?
Two out of three people seem to like the big gains of the first option. However, let’s put a pencil to it and calculate the actual returns. In the first year of option one you would have $190,000. But in year two with the 50% loss you would have $95,000 or a two year net loss of $5,000. If you choose the second option in year one you would have $140,000. But with the second year loss of 40% you would have $84,000 or a net loss of $16,000. If you chose the third option of a meager 4% gain in year one you would have $104,000. But with the second year gain of 4% you would have $108,160 or a net gain on your money of $8,160. So why would two out of three people choose option one? It is the allure of making 90% on your investment without weighing the risk of a 40% loss. Our brains see 90% is greater than 40% so I am still making a lot more money. Not so.
There is a reason that 50% of the American workforce has less than $2,000 saved for their retirement. Confused people do nothing. These are the options workers see and fall into traps. It only takes a small amount of money systematically set aside to allow compounding interest to work for you and not against you.
“The most powerful force in the universe is compounding interest” –Albert Einstein
Tim Wilhoit is owner/principal of Your Friend 4 Life Insurance Agency in Nashville, TN. He is a family man, father of 3, entrepreneur, insurance agent, life insurance broker, salesman, sales trainer, recruiter, public speaker, blogger and team leader with over 25 years of experience in sales and marketing in the insurance and beverage industries.