Yes, you can turn $3,000 into $50 million dollars. What’s the catch? It takes a long time. So, unfortunately, you won’t be around to spend it. But this is a great way to think about setting up your kids or grandkids for long-term financial success.
It’s really simple math that relies on compound interest to generate significant growth over many years. The basics:
- Invest $3k into a Small Cap Value Index Fund when your child is born.
- Assume 12% growth of that fund (which is the historical average for the last 100 years for SCV funds)
- As your child has earned income, slowly transfer the account balance to her Roth IRA to grow tax-free forever.
- At age 65, your child now has a balance of $4.75m.
- She starts taking out 5% / year from the account and it continues to grow at 12% / year.
- When she dies at age 95, over the last 30 years she has taken out and spent roughly $20m (5% / year) and the balance is $30m = $50m
Ok, does that seem far-fetched? Well, it could have easily happened over the last 95 years (if there had been a small-cap value index fund in 1926!
There are a number of ways to think about this for your own life:
- Invest some amount, whatever you can afford, for your child or grandchild. Let it ride for a long, long time.
- This could be for their retirement, or for a home down-payment or something else.
- Think about setting aside a small amount each month for something “down the road” for your kids, or grandkids.
- Invest in a single stock when a child is born for their high school or college graduation gift (whatever it grows to!)
The point is the earlier you can invest, the more compounding kicks in. The longer the child can stay invested, the more compounding works for them.
That's the good news.Julie: [:Mike: [:Julie: [:Mike: [:
Right. Okay. Good question. This is one of my favorite topics. . I've been following this topic for quite a few years by good friend, Paul Merriman. I will link to his articles and podcasts in the show notes. He has fantastic content and I love this article $3,000 into 50 million. All right. So we're going to go through that today for our listeners, how that works and there'll be some questions along the way, of course, but let's just dive into it.
All right. This relies on time and compounding. Might've already figured that out. And Einstein says compounding is one of the wonders of the world and I couldn't agree more. It's one of the things that our mind is very challenged to wrap itself around. Okay. I just mentioned that the pack of gum, it was literally 5 cents.
When I was growing up, I'd go to the corner store and get, five or 10 pieces for, less than a quarter. And now it's a couple of dollars I have to give my, I have to might get a couple of dollars to get like a bag of gum. So these things that are slow, it's like the frog boiling in the water so slow that you don't even realize it until
20 years later. Okay. So it does rely on compounding and we're going to get into the numbers, how this works. All right. You ready to go? Julie? All right. Let's give her a hypothetical child or grandchild named Brandon. When Brandon is born, we're going to take $3,000. . And invest it on Brandon's behalf.
So we're going to put it a hundred percent into the stock market. Now we're going to use a small cap value fund. All right. And that means it's invested in a diversified portfolio of small companies, more on the value side, not going to get into value and growth, but the point is historically when we look at small cap value over the last hundred years, researchers and academics love to look back in time and slice and dice the market because we all want to know how to beat the market.
And so they do tons of research on companies and past performance. And so small cap value stocks, which you can own thousands of them. So it's not just investing in a couple of companies that has one of the highest returns historically over 12% a year.Julie: [:Mike: [:
Of course you do. I do too. It comes with a lot of volatility. You could invest in that today and it might go down and you will not be breakeven for 10 years. That could happen. And then it goes on a tear at 25% a year for another decade. Okay. So it does go up and down a lot. But when you look at the last hundred years of history, the average is 12% a year.
All right. So Brandon is just born put in $3,000. We're hoping to get 12% a year of interest of growth, both interest dividends, reinvest in it and growth. . So we're going to let that ride for many years.Julie: [:Mike: [:brokerage account, just take $:
No problem. Just let it sit there. That works fine too. Now, when Brandon gets old enough that he starts having earned income. . He's teenager now mowing the lawns or getting the job and making pizzas down at the general store. Then he's got earned income. As soon as you have earned income, you can open up a Roth IRA and you can put that up to a hundred percent of that earned income up to a hundred percent or $6,000
whichever is less into that Roth IRA. Now you think Brandon's going to take his lawn mowing money and put it into a Roth IRA?Julie: [:Mike: [:
By the time he's 15, it was 15 years from now. So the rules will change, but right now you can give $15,000 a year to anybody tax-free under the gifting tax laws. And so he can put that money into Roth IRA. So over time, say teenage years through the twenties, we're going to take whatever that fund is now grown to and slowly shifted into his Roth IRA.
All right. So that's technically the best way. That we have today, laws might change of doing this because now we had that money growing tax-freeJulie: [:Mike: [:
. And you do that each year until this whole fund, is now in his Roth IRA. So that's technically how it's going to work, but the math works out basically the same. All right. So that's a great question. So now we got 12% a year. I'm going to spare you the details of the math, of course, but 12% a year over 65 years.
So now Brandon's gone through his whole career. All right. And it's 65 years later and that $3,000 has grown to $4.75 million.Julie: [:Mike: [:
He's thanking his late great Julie from 65 years later for this four, four and three quarter million dollars that is now in his Roth IRA that has grown tax-free and it's tax-free forever.
And it's great, but I promised them 50 million. So let's see how we're going to get there. He starts taking out at age 65. 5% of the value of the portfolio to spend on fun stuff for his family. Okay. And so then the first year he takes out 5% of that almost 5 million. So it's about $237,000 that he gets to take out of the account.
Now, the account is still growing at 12%. We're just assuming that straight line 12%, again, we know that some years will be down. Some years will be up. It takes out 5%, $237,000. It continues to grow. At age 70, he still takes out 5% a year. So that $237,000 has grown to $323,000. So at age 70, he takes out over 300,000 and it's still continues to grow at that point.
It's six and a half million dollars. That's just five years later, the compounding really starts kicking in down the road. Okay. So he keeps going until age 95 until his peaceful death at age 95. At that point, he's taken out 5% a year, which is total about $21 million he's taken out and spent. And the account balance is $30 million that he's leaving to his heirs.
So that's $50 million.Julie: [:Mike: [:Julie: [:Mike: [:
First 40 years slowly chugging along. But notice from age 65, it had grown to 5 million and he starts taking money out and it grows over from 65 to 95. Those 30 years, it grows to over 30 million, even with money, even with taking out and spending 20 million. So compounding kicks in significantly down the road.
If you can stick with it for the longterm.Julie: [:
$50 pair of shoes that you bought a year later has now cost you $400 or something. Ridiculous. And so when you think about it, this is the flip side to that.Mike: [:Julie: [:Mike: [:Julie: [:Mike: [:Julie: [:Mike: [:
Oh my gosh. Just stick it in one fund and you don't have to think about it for a couple of decades. But, that's all the other great news Oh, they were just born and you just do it. And then it's over there, done with, and we'll check in and 10 or 20 years, when we can start doing that Roth IRA stuff or however the laws, might be at that point.
All right. But let's talk about some of the things that might go wrong with this strategy. All right. First and foremost, 12%, Mike, really? So we talked a little bit about that. That is the history. That's the last hundred years. If you had done this, at certain points now certain points in US history, depending on when you started, you're going to get different returns and they could be pretty wildly different.
But when you zoom out to. 50, 60, 70 years they start averaging out. And so I don't have any other way of looking at it then history, right? We could say this time is different. We've talked about in the other podcast. Oh, maybe this time is different. Maybe, but I don't know what else to go on other than history.
And that's what the history shows and the good news is. You can get into this with very low costs these days. I It used to be buying stocks, you had to spend quite a bit, and there was no index fund. 50 years ago, you couldn't buy this fund, but now you can. And so this is a great strategy and I think 12%, I don't know if it's realistic or not.
I can only tell you that's what history shows.Julie: [:
just because this sounds great. Let's look at different numbers cause you're talking about $3,000 one time deal when they're born. So let's come up with another strategy that might be more beneficial in the shorter term.Mike: [:
All right. It's not going to matter too much at the end because you're adding so little, the portfolio would have compounded, but $365 a year for the first 60 odd years of Brandon's life would get you in the same boat. . Now the couple of things I noticed that right away is that's a long time.
365 is a lot less, one 10th. But I'm doing it for 60 odd years, rather than just like one time. So that's where you can really start noticing the compound effect. If you can get it in earlier, it's that much less money you need upfront two other scenarios. Just to drive home, the point of compounding, I don't have that much money.ear. So instead of a one-time:Julie: [:Mike: [:Julie: [:Mike: [:Julie: [:
I guess if I'm looking at, between 18, 17, 14 years, I guess,Mike: [:
So you're setting yourself up. And saying I'm going to cover some of his college costs. I better start saving now so that I don't have massive bills. When I do have those massive bills, at least I have some money set aside. Whereas the strategy we're talking about today is really for your child when they're in retirement, giving them money. And so do you see the difference, even though you're still saving now, one is for yourself. To help cover that goal that you really value. And the other is simply to give money, to your child now, the other way. And I do this personally, where I've been putting in some money for my kids, both for some college, for myself, and also a small fund that I'll eventually give to them.
And it can be for different uses. It could be for retirement. So we're talking today, how do you turn it into $50 million, which is fantastic, but it could also just help them out with them after college costs. Maybe the down payment for a first home, you know, things like that. You can start early and say, Oh, my child is just born or they're four years old.
Now I can put in a few hundred bucks a year, not going to really miss it potentially. And so maybe you can put in a couple of hundred bucks, let it ride for a little while. And then when they're 25 35, got a little pile of money, that's going to really help them out.Julie: [:Mike: [:
It's like a target date fund, which we talked about last time. It automatically shifts when they're five years old and 10 years old and 13 years old, it's automatically shifting the portfolio to have more bonds, which will give you less return overall. But will mean that by the time they're 18, 19, and going to college, that the money is there, and won't drop by 40%
all of a sudden you're expected to have a hundred thousand and now it just turned into 70,000. That won't happen because there'll be invested more in fixed income, cash and bonds at that point. So your return will be less over those 20 years, then it will be in this strategy.Julie: [:
Cause by the time my last one retires I'm not going to say how old I'll be, but I won't be here. I can tell you that.Mike: [:
So that is their money and you need to start having conversations with them. Hey, this is $1,500. Hey, there's $2,500, from your end in earned income, we're putting in a Roth IRA. What's this Roth IRA. You have lots of great conversations with that teenager, around this is what the money is and why it's here.
And it's about investing and growing. Let's talk about some of the other downsides, right? We said, where are you really going to get 12%? The other thing is that Brandon has to stick with this strategy, staying invested for the longterm, not start to rebalance. Not bring in those bonds, even in retirement with this portion.
Okay. Of what they've been given in their portfolio. If you want that 12%, you have to be, committed to a hundred percent in the stock market. It's going to go through its ups and downs, which is different than a general retirement. Portfolio, I'm not going to recommend being a hundred percent invested in the stock market necessarily.
But for this, that's what this strategy is all about. It's the supplement, obviously Brandon hopefully is working and saving and investing in his own 401k and doing all those smart things as well.Julie: [:Mike: [:
So going through the math, going through investing, going through the gifting, Hey, this is for you because we really care about you. All those kinds of conversations is just a great opportunity for education and support of a child.Julie: [:Mike: [:
when they're 45, as long as they're drug and alcohol free, you can put in all kinds of rules, the downside of that is you're going to be paying taxes. All right, is not an a tax-free account. And so the income and growth will be taxed whatever the laws are then, but that is a different kind of account type.
But again, there's pros and cons. Maybe that's a better way of going it's safeguarding the money. So it won't be squandered, in ways that you don't think are appropriate. And you're the one ultimately giving this money to a child or grandchild.Julie: [:Mike: [:
Now you had mentioned at the start to inflation. So let me just mention that briefly. All right. Historically we've had about 3% inflation. So I mentioned yes. Yeah. When you look historically over the longterm, it averages out to about 3%. Now that's wildly all over the place. Right now we're less than 2% and it's been like that for a long time.
We really haven't seen goods and services go up significantly. In the seventies, it was 10, 12, 17%. And we could have a whole conversation around bonds. Man we're Mike, we're not getting any interest on our US treasury bonds. It's half a percent, 1%. Yes. I know that. But inflation is low.
Did you know in the seventies? Yeah, you were getting 10%, but at 15% inflation, you're actually losing money. Okay. So it's all about being, in context, with these things. So what about 3% inflation, which is the historical average by the time Brandon reaches 65, I told you his account balance would be almost 5 million. . If you adjusted for inflation to think about in today's dollars, what does that really mean?
He'd have almost $700,000. So your $3,000 turns into $700,000. By the time he's 65 in real purchasing power. And that's pretty awesome. And in real dollars of the, I said 50 million with all that spend and taken out money and spending and the account balance at the end, the $3,000 turns into $3.6 million in todaysJulie: [:Mike: [:Julie: [:
So this is a nice way to feel like you're winning on one end of that spectrum.Mike: [:
gy. Oh, maybe I could afford,:Julie: [:Mike: [:Julie: [:
I mean, why not? You can't lose and it feels good to make some money on compounding interest versus losing it with all the other things we use it for, or it's used against us for, I should say.Mike: [:
I've done this personally at a place called M1 Finance. So you can look that up and they allow you to invest money automatically in a portfolio. That you can design and it automatically rebalances. So I have an automatic transfer of X dollars per month, maybe $50, $100 a month that you can take from your savings account into my M1 Finance brokerage account.
And it automatically gets invested into that small cap value fund or actually have three or four, 25% of this 50% of this little portfolio and it automatically is invested. So that's a great resource as well for putting this into action.Julie: [:Mike: [:
Maybe it's for one kid, I do it for multiple kids, just in one account, all the money's there it's for all the kids. I'll figure out how to split it up later on, but just for now, just to get started.Julie: [:Mike: [:Julie: [:Mike: [:Julie: [:Mike: [: