Aaaand yes, I’m sticking with my statement that we need to spend less money on dumb stuff and make sure that at the end of the month we have as much money left over as possible.
Because the key to becoming wealthy is to spend your money on the right things.
In today’s chapter, I want to dive into the importance of investing money and letting it grow on its own.
If you’ve read anything within the topic of financial education then you’ve almost certainly heard about compound interest.
Compound interest is your single best friend when it comes to growing your net worth.
“My wealth has come from a combination of living in America, some lucky genes, and compound interest.” — Warren Buffett
The problem with saving
There’s one big problem we face when it comes to growing our wealth by saving: Inflation.
Inflation — in simple terms — is the devaluation of cash.
Many people make the mistake to believe that 1$ will always be worth 1$.
While it’s correct that 1$ will always BE 1$, it will not always BE WORTH 1$. That’s because our whole monetary and economic system is run by growth.
Continuing growth is only possible by increasing the amount of money in circulation. The increased amount of money in circulation means increased availability of money and therefore the value of money sinks.
That’s what’s called inflation.
While a few decades back it was easy to grow your money by saving it due to the high interest rates we had, nowadays you get almost nothing from your bank for keeping your money there.
In the mean-time, your money’s value drops significantly each year. Officially by around 2%, in reality probably way higher than that.
So what are we going to do?
Well the only thing we can do really, is to spend our money on places that make us money. In simple terms: we need to invest it.
While things like stocks and real estate come to mind immediately, I personally consider things like insurance an investment too. One you hopefully never need but in theory, insurances can do one thing for you that’s extremely important when it comes to investing and life in general: they limit your downside. More on that another day.
I really like Robert Kiyosaki’s metaphor that every single dollar is a worker in your company. We can spend it and give that worker to somebody else or we let that worker work for us.
Compound interest is your friend
So what is compound interest?
If I invest 1$ with an interest rate of say 5% then next year I will have 1,05$. If I stay invested the next year I will get interest on those 1,05$, so my interest payout will be higher. Keep this up for 10 years and you have 1,63$. Doesn’t sound much?
Let’s say you’ve read Chapters 1–4 and manage to set aside 100$ each month. That means you save 1200$ a year. Keep this up for the 40 years of your working life and you will have 48000$ at the end. Pretty neat.
What if you had invested those 100$ each month with an annual interest of 8% (the average ROI for the S&P500 in the past decades)?
In 40 years you’d be sitting on a staggering pile of 337,909.70$. That’s quite a difference. Almost a 290,000$ difference, to be exact.
What happens if you invest more? Well, the more you save, the higher the payout of your interest will be. The more you invest, the more interest you will receive.
200$ invested each month? Worth 675,819.40$ in 40 years.
500$ invested each month? Well… congratulations, in 40 years you will be a millionaire: 1,689,548.50$.
In times of historically low interest rates it’s become harder to find an investment that pays out a decent rate. Putting your money on the bank is not going to be of much help. Investing is.
No, I’m not telling you to rush and buy every stock there is. I can’t because first of all I’m not a financial adviser and these are my own opinions only. And secondly, because I think to invest in stocks at the current point comes close to hanging yourself when it comes to risk vs. reward.
There are other options that I’ll dive into another day.
For now, let’s end with this:
You have seen the power of compound interest. You know that it is your best friend in building wealth. Combine it with keeping your workers with you and letting them work *for* you instead of against you then you can build enormous wealth by the combination of discipline and time.
The Disclaimer: This is not financial advice but for entertainment purposes only. I am not a financial adviser and these words reflect my personal opinion only. If you need financial advice, ask a professional.