Updated: Nov 3, 2020
As I mention a lot, the key to building long term wealth is pretty simple. Now I am choosing that word "simple" carefully because it should not be confused with easy. It's definitely not easy at all building wealth, but it is 3 simple things:
1) Work hard and build a stable and growing income
2) Live below your means and save money every month
3) Invest effectively, focusing on avoiding drawdowns and setbacks
I'll make today's topic into a video soon because I think this is a very important subject to understand. Now some of you will already be aware of how important regular additions are in the long term process of building wealth, and I hope you're already well under way in that endeavor. Consistently living below our means and adding money to the account every month is one of the most powerful growth tools we have at our disposal.
However, many investors just haven't seen it illustrated before so they don't realize the compounding effect it can have.
So true Mr. Einstein, so true!
So let's take a real world example, using the Total Portfolio Solution since I launched VTS on January 1st, 2012 as our example. It's returned an annualized 20% a year since inception.
Start with 25,000$, no additions:
An investor who started with 25,000 in January 2012 and just left the account to grow over time would now have 124,547.74$.
If we back out their original 25,000 investment, that translates to a net gain of 99,547.74$.
Start with 25,000$, adding 1,000$ a month:
Now let's compare that to another investor who started with the same 25,000 investment in January 2012, but they consistently lived below their means and added 1,000$ a month to the account. They would now have 316,400.24$ today.
If we back out both the 25,000$ original investment, plus the 104,000$ they added in the 104 months since inception, they are still left with a net gain of 187,400.24$
Now it goes without saying that the person who added to their account every month will have more money, but pay close attention to the difference in NET account value change:
- No monthly additions net gain: 99,547.74$
- Regularly monthly additions net gain: 187,400.24$
As you can see, even though we have fully backed out all the original capital plus the monthly additions, the person who made regular contributions will have nearly double the amount of profit.
That is the power of compounding that our friend Albert Einstein was talking about!
Every penny of additional funds added to the account along the way also get compounded from that moment forward. This is the snowball effect that helps people generate long term wealth. The larger the account gets through regular additions of capital, the more benefit any further rate of return has.
Get rich quick is futile. I suggest you get rich smart!
There are plenty of people trolling Twitter looking for strategies that will make them a millionaire, and unfortunately, plenty of frauds who will claim they can help people do it. This social media driven world has convinced people that they can just start with a set amount of capital (usually a small amount) and then just get insane returns and multiply that original amount into a million dollars. I wish them luck of course as I do want everyone to succeed, but I have no confidence it will actually work out for them. In fact I'm quite sure that kind of risk taking will just lead to them losing the original amount when the market does something unexpected.
There is a much better way with a high probability of success.
1) Build a stable income
2) Live below your means and add money to your account monthly
3) Make a realistic, consistent long term return.
With just that, father time will make you a multimillionaire.