September 25, 2016


How time can turn $3,000 into $50 million (PAUL A. MERRIMAN, 12/28/15, Market Watch)

The plan I am about to describe isn't magic. It's a recipe with four essential ingredients:

An initial investment of $3,000
A Roth IRA
An investment that's likely to grow at 12% over a very long time
A long lifetime (plus ample patience).

Want to try it? Here's how, using an imaginary infant named Brendon for the example.

When Brendon is born, set aside a lump sum of $3,000. Invest it in an ETF or a mutual fund that holds small-cap value stocks. (To learn more about this check out my podcast called The Best Small-Cap-Value ETF.)

Leave the money in that asset class to grow. And grow. As soon as Brendon has taxable earned income, start contributing the money in the account to a Roth IRA in his name, keeping it invested in small-cap value. That way, at least under current tax law, it will never be taxed. Do this every year until all the money is within a Roth account.

Assuming that Brendon leaves this money alone and that it continues to compound at 12%, when he is 65 years old, your one-time $3,000 investment in small-cap value will be worth about $4.75 million.

That is still far short of $50 million. Let's follow the money and see how this scenario plays out.

Assume that at 65 Brendon starts withdrawing 5% of the balance of his small-cap value account every year. That first year, he takes out $237,281. (Compare that figure to your $3,000 investment.) Because the money continues to compound at 12%, his balance grows, and so do his yearly withdrawals.

When he's 70, he'll take out $323,572, based on his account value of $6.47 million. At 80, the account is worth slightly more than $12 million, and he takes out $601,710 -- theoretically without any tax liability.

If we assume Brendon keeps this up until his death at 95 (his final annual withdrawal being $1.5 million), his account will be worth about $30.5 million. Starting at age 65, he will have taken out a total of $21.6 million. That final value plus all the withdrawals come to more than $50 million from your initial $3,000. And, presumably, very little of it will have been taxed.

Just making federally-funded contributions to a sort of tax-free O'Neill Account for every kid and then means-testing SS benefits essentially ends the program.

Posted by at September 25, 2016 6:49 AM