Compound Interest

The most important thing about investing is just saving part of what you earn. This
has been well understood for many years. Mr. Micawber, a character in Charles
Dickens Oliver Twist, said this in 1850, Annual income twenty pounds, annual expenditure
nineteen pounds nineteen and six, result happiness. Annual income twenty pounds, annual
expenditure twenty pounds nought and six, result misery."
The second most important thing is to understand the effect of compound interest.
If you saved $1000, earned 8% per year and never added to it, after 40 years, you
would have $21,735. If you save $1000 per year for 40 years and earned 8% per
year, you would end up with over $259,000. If you waited until 20 years before
retiring and saved $2000 per year at 8% for 20 years, you would end up with just
$91,500. So the longer you can save, the better the results.

Realistic expectations
Since 1928, US stocks, as measured by the S&P 500 index, have returned 9 -10%
annually, while US ten year treasury notes have returned 5-6% annually. However,
stocks have been far more volatile. They have returned as much as 52% in 1954
and lost as much as 44% in 1931. Is that ancient history? Not when you consider
that stocks returned 37% in 1995 and lost 37% in 2008. Overall, stocks have
gained in value during 63 years but lost money in 24 years, including 11 years when
they lost at least 10%. And if you lose 30% one year, but gain 40% the next, you are
still in a net loss position.
Bonds, as measured by US ten year treasury notes, which are issued four times
each year, have returned as much as 24% in 1995 and lost as much as 11% in
2009. Bonds can lose money even though they pay interest every year if market
interest rates go up, which causes older bonds issued with lower coupons to fall in
price so as to have a yield that is similar to the newer bonds. Overall, bonds have
made money during 70 years and lost money in just 16 years and of those 16, there
were just 5 years where the loss was more than 5%.