Build Your Asset Army - Compound Interest
Build Your Asset Army & Achieve Financial Freedom
There is an analogy that really stuck with me when learning about money that I still use today. When you start thinking about money differently it can motivate you to follow your budget and remind you why you are focused on making smart money decisions.
Every dollar that we make is like a tiny soldier in our personal freedom army. We all start by trading our time to earn each dollar and with each dollar we make we have two choices. Spend it, 0r invest it. It's completely our choice what to do with our money soldiers. We are the General of our own army of money soldiers, and we decide their fate.
We have a choice to send each of our soldiers off to the front lines for certain death by spending it or we can save and invest our soldiers. The soldiers we 'save' or 'invest' will continue to grow and produce more soldiers. When you put these newly generated soldiers back to work by reinvesting them, you will start to exponentially grow your army. This is how compound interest works. Financial independence is when you build a big enough army that you no longer have to trade your time for money because your soldiers produce more than you need to live.
It is a fairly basic concept but I like how it helps visualize what savings can do for your financial future.
In the end, you will have enough soldiers that you don't have to work and you no longer have to fight your own war. Your asset army will fight it for you. In the meantime, keep fighting the good fight.
Let's Look At A Real Example Of How Compound Interest Works
When you save and reinvest your earnings you will see how quickly your money can grow and how the wealthy make most of their money. At first it's an uphill battle. You can see below that after year 1 a person contributing $500 per month only earns $480 dollars in interest on their $6,000 investment at 8%.
However, the longer you invest and continue to reinvest your earnings, you quickly start seeing why compound interest is such a powerful tool. In year 10, the same person has contributed a total of $60,000 by contributing $6,000 per year for each of the 10 years and has earned a total of almost $32,000 of interest on top of that for a total of $93,873.
In other words, in year 10 this person has earned a 56% return on their $60,000 contribution and of the $93,873, $33,873 of it was earned through compound interest. That's a significant amount.
So what this means is that if someone can contribute $500 per month for 10 years they will be sitting on nearly 94k and over 33% of that was earned in interest. This is exactly what Albert Einstein was talking in his quote.
A person's wealth or 'Asset Army' will only continue to grow exponentially as they continue to invest and continue to reinvest. You may hear some people refer to this as a snow ball effect in terms of how your money will grow. This example is only over a 10 year period. If you were to consider what this looks like over a 30 year working career the numbers are much bigger.
This is exactly how Warren Buffet's wealth was build, granted he did a pretty good job of it. Look at how his total wealth was built over the years. Look familiar?
This is what is referred to as the Warren Buffet wealth hockey stick. More like Holy H-E-Double hockey sticks! That's a serious asset army.
But stay with me, we don't all need to be as savvy as Mr. Buffett, there is a lot of lessons to be learned from him. If you were able to continue to contribute the same amount as the previous example over 30 years you will have a total of just over $740,000 while contributing only $180,000 in total contributions.
If you thought the 10 year numbers looked good, you'll be even more psyched by the long term picture. This means that you have nearly a quarter million dollars in 30 years and $560,000 was earned through investment returns. That's over 75% of your overall earnings built through interest.
Sweet. But How Do I Save That Much?
It's not always fun to think long term but hopefully this illustration shows why it's so important to continue to invest and how most people preserve and grow their wealth.
One of the best ways to focus on saving money and grow this kind of wealth is through your company 401k, 403b or traditional IRA. The advantage of these accounts is you get to defer paying taxes until you need to take out this money as income in retirement. Even better, you contribute at your highest tax bracket.
If you are able to contribute $6,000 a year it really only feels like $4,500 or $375 a month if the top of your earnings are in the 25% tax bracket.
If you focus on your budget and save this amount before it hits your checking account you likely won't even miss it and you'll wake up 30 years later with an asset army that allows you to do whatever you want with your time.
I Don't Want To Wait 30 Years!?
I like your attitude. There are several options on how to get to retirement sooner or build a working retirement. You will have to do one of two things. You either have to save more than the example in this post or you will have to learn to live off less sooner. With a 4% withdraw rate, which is widely considered a safe withdraw rate, you can withdrawl $30,000 a year on top of social security. If that won't work than you should consider working longer, or saving more in your working years so you can have more money and retire earlier.
What am I doing?
My recommendation is to focus on a working retirement. When you have met your investment goals and paid off your debts, you can start building a working retirement. What this means is you focus more on working how you want to work, not retiring. Why retire by 40 when you have so much to give. Focus on what you want to give to the world. There are so many more options when you don't need to make as much money. It allows you to take chances and take risks. In the meantime, focus on building your asset army so you give yourself options in the future.