Many hucksters claim to offer a shortcut to wealth. They promise to increase your investment returns to some dazzling level: 100% a year, 50% next week. The problem is that neither they, nor anyone else, can achieve those results over a sustained period. Anyone who tries to build wealth by dreaming of spectacular returns year after year is likely to end up in the poorhouse.
I recommend a totally different approach. Amass your fortune the time-tested, old-fashioned way. By all means, strive for the best profits you can earn, without taking excessive risk. But recognize that the decision to grow wealthy rests with you and your personal lifestyle.
The Time-Tested Path to Wealth
If you want true financial independence, without a money worry in the world, you must learn the habits of a champion saver. My wife Enid and I got into the groove more than 35 years ago, when we were first married. We were living on one income (hers) while I was studying law at the University of Virginia. Enid took home about $130 a week as a legal secretary.
Yet, in spite of our low income as a student family, we squirreled away cash every week in the bank. I opened a brokerage account and started trading stocks. By the end of our second full year of marriage, we already had interest, dividends and capital gains running at nearly 15% of our wage income. The process fed on itself, so that in recent years these investment items have occasionally surpassed 30% of my work earnings.
Saving, then, is — for most people, other than the Bill Gateses of the world — the key to achieving a substantial net worth. Let’s assume you start with $25,000 of investments at age 40. You’re earning $80,000 a year, and you can count on a 3% pay raise each year. If you save 20% of your salary (not impossible, I’ve done it for years) and invest your money at a moderate 8% annual return, your $25,000 nest egg will grow to $324,554 in just 10 years — an increase of almost 1,200%!
Please note: I’m not saying that $25,000, left alone at 8%, will grow to $324,000 in 10 years. (The original $25,000 stake will only increase to $53,973.) You must keep adding to the kitty, through savings, if you want to enjoy the miracle of compounding. As Ben Franklin said, “Money makes money, and the money money makes, makes more money.” By adding to the account at regular intervals, you enlarge your investment base. As a result, the dollar amount of your wealth will grow much faster in later years than it would if you simply sat on your original $25,000 stake. This is true even though the percentage growth rate in your portfolio (which we’re assuming to be 8%) never changes.
What’s the practical impact of the advice I’m giving you here? Let’s bring the point home with an example. If you simply left your original $25,000 account undisturbed, the annual growth in year #11 would only amount to $4,317 — hardly enough to buy an older used car at today’s prices. By contrast, if you followed my advice, you could stop contributing to the account at the end of year #10 and buy yourself a nice new American car with the next year’s earnings for $25,964.
Incidentally, stepping up your savings is also the secret to retiring earlier (if that’s your goal). Let’s say you’re 40 years of age, again earning $80,000 a year, and you figure you’ll need $20,000 a year of investment income (over and above the pension you may get from your employer) to retire comfortably. We’ll assume three things:
- You start with no investments
- You collect a 3% pay raise each year
- Your portfolio earns 8% annually
If you save only 5% of your earnings, you’ll reach $20,000 of annual income by the time you turn 61. But now let’s say you decide to speed up the process. You’re determined to get out the door sooner, so you boost your savings rate to 11%. You’ll achieve the $20,000 in annual income by age 54 — seven years faster. In fact, if you really want to be a champion, you can push your savings rate to 20% and retire at 50.
As you can see, your retirement date is really up to you. How strongly do you feel about having more leisure time to do the things you’ve always wanted to do? If the goal is an important one for you, let me assure you: It’s within your reach. All you have to do is save.
5 Tips for Navigating the “New Normal”
I don’t have to tell you the economic and financial world has changed. Radically. I don’t even have to remind you that the changes are probably going to be with us for a long time. Truth be told, though, many of us are still in the early stages of adapting to a climate of slower growth, tighter budgets and fragile investment markets.
I’m adjusting, myself. As part of the process, I thought I would share with you a few principles I’ve drawn up to help pilot my ship safely through the financial rocks and shoals of what people everywhere are calling the “New Normal.”
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