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Nov. 13, 2015, 12:35 p.m. EST

Putting Einstein to work for your investing future

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By Paul A. Merriman

About Paul

Paul Merriman is committed to educating people of all ages to get the most from their retirement investments. Founder of Merriman Wealth Management, a Seattle-based investment advisory firm, he is the author of numerous books on investing: "Financial Fitness Forever," "Live It Up Without Outliving Your Money," and the new "How To Invest" series, free at his website:  "How To Invest" series: "First Time Investor," "Get Smart or Get Screwed: How to Select the Best and Get the Most from Your Financial Advisor" and "101 Investment Decisions Guaranteed to Change Your Financial Future." In his retirement, Paul writes a weekly column at MarketWatch and continues his weekly podcast, Sound Investing, which was recognized by Money magazine as "the best Money Podcast in 2008". He is president of The Merriman Financial Education Foundation and all profits from the sale of his books are used to advance financial literacy. His recommendations for portfolios of Vanguard funds, Fidelity funds and ETFs, podcasts, articles and books are available at paulmerriman.com. Follow Paul on Twitter @SavvyInvestorPM.

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No matter what your age, or how much or little money you have, you can put one of Albert Einstein's insights to work for you. That's a very smart thing to do, and I'm going to show you how.

This is the second part of a series on compound interest, which was famously cited by Einstein as one of the wonders of the world. You can read the first column here.

In my previous column, I showed how the formula works over a variety of time periods (20 years out to 100 years) and for five compound rates of return that are reasonable for investors to expect, depending on how much risk — or how little risk — they decide to take.

To reiterate what's obvious to anybody who has thought about it, higher long-term results come from longer periods and from higher rates of return.

The tables I cited show the hypothetical growth of $1,000. At the shortest and most conservative end, that sum grows to $2,191 when invested for 20 years at 4%. On the other end, $1,000 grows to $83.5 million when invested at 12% for 100 years.

For most investors, somewhere in the middle of those extremes is much more likely. So that's what we'll focus on here.

We will look at three hypothetical investors: one is a 25-year-old person starting a career with enough income to set aside $5,000 a year. The second is a 45-year-old person who has saved $120,000 and continues to add $5,000 a year. The third, a 65-year-old new retiree who has a $1 million portfolio and expects to live another 30 years.

The 25-year-old woman

Young investors have an extremely precious resource: time, which works wonderfully with compound interest. However, setting aside money when you're young isn't necessarily easy. Student loans, new households, growing families, and day-to-day living all have important claims on a young person's income.

But the tables from my previous article show what's possible. Let's assume a 25-year-old invests $5,000 (only once) in equity funds and earns 10% over the years. At age 65, her single $5,000 investment will be worth $226,295.

Lesson: Even a relatively unspectacular return like 10%, if it's given lots and lots of time, can produce amazing results.

After 40 years of putting in $5,000 a year and earning 10%, she would have about $2.21 million.

For this example, I chose 10% because history suggests it's reasonable to expect that from investing in only the S&P 500 Index. In my prior column, I suggested 12% is a quite reasonable expectation for somebody investing in small-cap value stocks for the long haul.

If this woman put half her money in the S&P 500 and the other half in small-cap value, she might earn 11%. At that rate, her first $5,000 investment would grow to be worth $325,004 instead of "only" $226,295. That extra amount, by the way, is nearly 20 times the original number of dollars she invested.

And at age 65, if she did that for 40 years, she'd have a portfolio worth $2.9 million.

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