Welcome everyone to my first Substack post. Let me start with a brief introduction and then I’ll move to the task at hand – some thoughts on building wealth (and the three key drivers – saving, rate of return, and time). I taught finance and investment classes at a mid-sized, Midwestern university for about a quarter-century before retiring. During that time, I created a YouTube channel that makes enough money to keep my Diet Mountain Dew habit mostly in check and helps provide a nice sleep aid to finance students across the globe. My newsletter will cover a mix of topics ranging from investments, personal finance, book reviews, decision-making, and whatever topic I feel like covering. I don’t plan on having a subscription fee, so the cost is your time…which for most of us is a precious and limited resource. I’ll try to respect that (for the most part) and hopefully make it worth your time. If you did happen to stumble across this and find it worthwhile, please share it with a friend or two.
Morgan Housel (a brilliant writer – if you haven’t read his work, you should) argues that chasing high returns is not the key to generating wealth. Instead, it is returns over time:
Likewise, investors’ goals shouldn’t be the best annual returns. It should be to maximize wealth. And you get that through endurance – not to be the best in any given year, but to be the last man standing.
Charlie Munger notes
Spend less than you make; always be saving something. Put it into a tax-deferred account. Over time, it will begin to amount to something. This is such a no-brainer.
At this point, we’ve introduced two of the three levers to developing wealth, time and saving. The third also snuck into the picture in disguise when Mr. Munger mentioned tax-deferred, as that effectively increase our rate of return. It is important to note that tax-deferred does not mean that you are cheating the system. Instead, these are accounts such as Individual Retirement Accounts and 401(k) plans (among others) that the US government has introduced in order to encourage people to save.
Now let’s introduce a few examples. Currently, the maximum an individual can invest into an IRA is $6000 per year (which breaks down to $500 per month). Our first lever is time. To look at this, consider saving $500 per month for 10 years, 20 years, 30 years, and 40 years at an 8% rate of return (for reference, the rate of return on stocks in general with dividends reinvested in the US since January 1929 – the year that kicked off the Great Depression – has been 9.7%).
After 10 years, you would have $91,473 (here is an online calculator if you want to check the math or try different combinations). This is good, but keep in mind that $60,000 is money out of your pocket, and $31,473 is from investment income (what you actually earned by getting that 8% return). What happens when we go to 20 years? Our wealth grows to $294,510. Even better — and this time instead of increasing our wealth by about 50%, almost 150% is investment income. Extend out to 30 years and we’ll have $745,180. This time $180,000 has come from our contributions and $565,180 is from investment income. Finally, at 40 years, we’ll have $1,745,504. A mere $240,000 has come from our pocket and over $1.5 million has come from investment income. In other words, we’ve gone from generating 50% of our savings in investment income to over 527% from investment income! Over the last year, you will earn $139,521…which is over 4 times what you made over the first 10 years combined! Time is powerful.
What about our rate of return? Let’s redo the $500 per month at 3%, 6%, and 9% for 40 years. For perspective, here are some sample asset class returns over the 1991-2000 time frame.
At 3%, we will have $463,030. Remember that $240,000 was our contributions, so we have not quite doubled our money. At 6%, we’ll have $995,745. This is much better. However, what happens at 9%? At that rate, we have $2,340,660. Yikes! Small differences in return add up over time. If you really want to see some compounding, try a 12% return. You’ll end up with nearly $6 million at the end of the 40 years. All of this is with $240,000 out of your pocket.
The last lever is savings. In these examples, we did $500 per month. What happens if you only put in $100 per month at 8% for 40 years? Under this scenario, you end up with $349,101. Granted, you have only contributed $48,000 instead of $240,000, but your wealth will be quite a bit smaller.
Wealth is like a snowball. The more you contribute, the bigger the snowball will be initially, which will allow it to grow even larger over time. The higher the rate of return you earn, the faster the snowball will grow with each spin. The longer the hill (time), the snowball has more time to grow at the end when it is accumulating the most.
Investing will make you look like a sucker early on, as the first decade often does very little for generating wealth. However, it forms the base that allows you to accumulate more wealth later on. Remember your three levers – time, rate of return, and saving – and you’ll be on the right path. You won’t get rich overnight (or even over 5-10 years), but it will put you on a path to financial independence over time.