Christopher Nolan’s 2006 film “The Prestige” opens with actor Michael Caine describing the three steps of a professional magic trick.
“Every great magic trick consists of three parts or acts. The first part is called ‘The Pledge’. The magician shows you something ordinary: a deck of cards, a bird or a man. He shows you this object. Perhaps he asks you to inspect it to see if it is indeed real, unaltered, normal. But of course... it probably isn't. The second act is called ‘The Turn’. The magician takes the ordinary something and makes it do something extraordinary. Now you're looking for the secret... but you won't find it, because of course you're not really looking. You don't really want to know. You want to be fooled. But you wouldn't clap yet. Because making something disappear isn't enough; you have to bring it back. That's why every magic trick has a third act, the hardest part, the part we call ‘The Prestige.’”
Compounding interest is a lot like a magic trick, but unlike magic, it is real. It’s simply math. That’s why it is not magic for me to tell you that you can turn $30 into $1 Million. When my son was born a few years ago, I decided I was going to start investing immediately in his future. I developed a simple, affordable, achievable plan to accomplish that goal. And it all started with $30.
The first part of any good magic trick is the magician showing you something ordinary. In this case, it’s $30. 10 cups of coffee. 3 movie tickets. A reusable water bottle. A tank of gas. $30 does not go a long way these days, and most of us could easily spend $30 on Amazon without even thinking about it. It’s a pretty ordinary amount that can only buy you ordinary things. Here’s a challenge: try to think of one thing you could give up that would cost you $30 in a month. It’s not overly hard to do if you set your mind to it. The first part of my investment plan involved a $30 commitment per month. I set up a simple brokerage account through the investing app M1 Finance in about 15 minutes.
As an aside, here’s a shameless plug for M1. M1 provides a commission-free, simple platform to invest in stocks and exchange-traded funds (ETFs), and they even offer fractional shares so that you do not need a large amount to invest up front. Further, they offer “pies” which allow you to automatically invest in “slices” of stocks or ETFs that you choose. M1 will automatically rebalance your portfolio for you at no cost every time you make a deposit. You can also set up automatic transfers from your bank account on a recurring schedule to make investing $30/month even easier! We will be doing a more in-depth review of M1 in a future blog post, but if you are interested, sign up with this link and get $20 free just for opening your account. That’s $20 you can use towards your $30 goal! M1 is one of the best free investing platforms for new investors on the market right now.
So we start with a $30 monthly investment. Nothing special, just some diligence to forgo those 10 monthly latte’s at Starbucks to save for a loved one’s future. Now, onto the next act!
The magician has shown you the ordinary pledge. Now is where you are looking for something extraordinary to happen. Unlike a quick magic trick, “the turn” of turning $30 into $1 Million takes a whole lot of patience. Like the audience waiting to find out what happened to the item that disappeared, you are not going to see it at first. I can tell you right now, I am still in “the turn” phase of my investment plan for my son. I have about $400 in my account. Wait, wait, wait...that’s $999,600 short of my goal! How is that impressive? The impressive part is still to come.
During this second phase of the compounding interest trick, two key components are required from you: consistency and patience. If you start investing $30 a month in your account, assuming you invest in an S&P 500 fund like the ETF SPY, it is going to take exactly 58.83315 years for your investment to become $1 Million, assuming a 10% compound annual growth rate (CAGR).
There are some other key strategies and factors to consider during this phase of growing your child’s investment.
Since you are starting out investing in a brokerage account, as long as you do not sell the investments you are buying, you will not be taxed on the account. If you do happen to sell any investments in the account, you will have to pay taxes on the earnings you made.
When your child gets their first job, you can roll the brokerage account funds into a custodial Individual Retirement Account (IRA), which essentially transfers the funds into your child’s name in a tax-advantaged account, but under your custody until they turn 18. By doing this step, your child will also be able to contribute from their own earnings into the IRA. This is a great opportunity to have a discussion with your child about the power of compounding interest and the importance of delayed gratification for future financial security. Make sure to consult with your accountant or financial advisor about any tax implications of opening a custodial IRA for your child.
One creative way to encourage your child’s participation is to offer a dollar-for-dollar match on any contributions your child makes to the IRA. With your child contributing to the IRA in addition to your $30 monthly commitment, the time it takes to grow the account to $1 Million can also be reduced significantly.
The reason I suggest investing in an S&P 500 ETF is 1) your investment is diversified across the stocks of 500 companies, 2) the S&P 500 has historically returned nearly 10% annually since the 1920’s, and 3) you will not have to rebalance your portfolio between different funds, which will trigger taxes you have to pay on your earnings.
Once your child is 18 and the IRA is in their possession, it is your decision whether to keep contributing monthly to it as a gift, or encourage them to continue the same contribution you put in for the first 18 years. The key to reaching your goal is for either you or your child to keep contributing monthly for the long-run.
So now, the final act. The audience has been waiting so long, it probably seemed like it would never happen. All of a sudden, the minuscule $30 you and then your child were contributing monthly for so many years is a significant nest egg of $1 Million. It may have taken 58.8335 years, but your small monthly commitment to not click “buy now” on that $30 Amazon order became $1 Million for your child before the age of 60. In fact, if your child rolled that custodial IRA you set up into a Roth IRA, the timing is nearly perfect because of the minimum age of 59 at which they may start taking withdrawals tax free from their account.
There are so many prestigious lessons to be learned from this incredibly simple method.
Mathematics - it is astonishing that every dollar you invest when your child is born is worth $271 in just under 59 years, assuming a 10% CAGR. In other words, that $30 item you ended up not purchasing is really worth $8,130 for your child in 59 years!
Society - the ramifications of this experiment shows that nearly anyone of any socioeconomic status, choosing to be diligent and patient, can entirely change the course of their family tree by creating wealth for their descendants. This has huge implications for helping break cycles of poverty and despair through proper education and the empowering knowledge of simple financial disciplines. Technology like the M1 app makes these kinds of opportunities even more accessible to everyone.
Families - it cannot be understated how important parents are in the decisions they make for their families, and the impact they have on their children. Through discussions about money and how to learn wisdom from a young age, parents can model faithfulness, discipline, patience, and delayed gratification to their children. Furthermore, kids are given the opportunity through this savings method to actively participate in their financial future and have “skin in the game.”
These are just a few of the incredible applications of how a $30 monthly investment can actually become $1 Million in your child’s lifetime. Michael Caine ends his narration of “The Prestige” by saying, “The magician takes the ordinary something and makes it do something extraordinary. Now you're looking for the secret... but you won't find it, because of course you're not really looking.” Are you looking?
Disclaimer: Past performance is no guarantee of future results, which may vary. Investing involves risk, including possible loss of principal. The value of investments and the income derived from them may fluctuate over time. All portfolio returns and scenarios presented are hypothetical and back-tested. The opinions and views expressed by the author do not constitute investment advice or recommendation, and are provided solely for informational purposes, and are not an offer to buy or sell any securities.