Let’s start with what this article is not:
- It’s not a get rich quick scheme
- It’s not an article comparing different sources of cash flows (I’ll do a separate article on that later)
This article is about developing long term wealth the old fashioned way.
The “method” works for everyone, whether you work a 9-5 earning a minimum wage, a high paying career, or a business.
However, this article is oriented towards people who work a salaried job (because the upside can’t be increased significantly).
I present to you – the 2-step process to wealth:
Step 1: Save Aggressively
Start with reading my excellent article on saving 20% of your income.
Cut down on unnecessary expenditure – especially recurring expenses.
You’ll be surprised how far that gets you.
Lets take for example that you spend:
$12/week for coffee
$10/week for magazines
$200/month on takeout lunch food
$40/week on alcohol
Here’s how much you’d have in 10 years at a conservative interest rate of 5% and a more realistic portfolio return of 7%:
$77,700. That’s a small fortune. That’s how much you can have in 10 years just by being careful with your money. That may not seem like a big enough number to some of you, so here’s the same calculation, but for 20 years:
$230,500. Doesn’t seem too small anymore, does it? Welcome to the world of compound interest.
Here’s how much you’ll have when you are 65 (45 years of compounding, assuming you’re 20 now):
More than $1.6 MILLION.
If that doesn’t jolt you awake, nothing will.
This does not mean you become frugal. This means you become aware of the *value* behind every purchase. Price is what you pay, value is what you get. Warren Buffet said that. You spending $20 on takeout is good business for the restaurant – not good business for you.
BE SMART WITH YOUR MONEY WITHOUT BEING FRUGAL.
If you’re out with a client team of 5? Buy all 5 of them lunch and coffee.
Cooking at home will save you money AND your body will thank you. So will cutting down on your alcohol consumption.
Spend as much money as you like on books, but not magazines. No RoI.
If you really must read magazines, don’t buy a physical copy at the shop, buy a digital copy on your phone. Your wallet and the tree where that paper came from will thank you.
Avoid coffee shops – I can assure you that they’re all overpriced.
Your financial pain and discipline will reward you big time.
(in case you’re thinking of inflation – the above calculations assume that the amount spent over coffee, alcohol, food, magazines etc remains the same over 45 years. In reality, the prices per unit of consumables will also increase with time, thus your savings increase each year – which should be more than sufficient to offset inflation)
Even if you can set aside just $2,000 that you made over the summer, that’ll amount to $42,000 by the time the retirement bell rings.
At minimum, you should aim to save at-least 20% of your income.
Step 2: Invest Strategically
It’s crucial that you invest your money correctly. It doesn’t matter how much you invest – what matters is that you start – the sooner you start, the more you can compound.
First, you want to safely set aside 10% of your money as a rainy day fund – it’s for real emergencies only.
The balance – invest in Stocks, Bonds and Gold. (Ideally, you should also own some real estate for diversification, but that is beyond the scope of this article)
(In case you have a mortgage, student loans, or any other kind of debt – make sure to use the savings to pay those off first – pay them off as much as your contract lets you. Invest money when you are debt free.)
Bonds are stable give you safe returns. Bonds stabilize your portfolio. Gold is an insurance policy. Stocks, in the long run, bring you high returns. (If you’re Indian, you can put money in Fixed deposits instead of bonds – the returns are similar)
Here’s the breakdown that I would use:
- The bond percentage should be as much as your age. When you’re 25, invest ~25% of your portfolio in bonds, 5% in gold and the balance 70% in stocks. This is because you have more years in your life to ride the waves of the market – and chances are, you will make money more often than you lose it – you’ll come out ahead in the end.
- When you’re 40, it should be 40% bonds, 5% gold and 55% stocks. At 50, half your portfolio is bonds. As you age, you extract risk from your portfolio. When you’re 70, your portfolio is mostly bonds, and barely any stocks.
(Also read – Long Term Investing: Building An Equity Portfolio)
And that’s it – that really is how wealth is built. If you were looking for the “secret” of wealth – you’re sorely mistaken, there isn’t any.
To recap: Save, Invest, and Reinvest. It’s tried and tested and true – and anyone can do it.
Too bad most people won’t – they’d rather sip $10 coffees and buy $300 shoes and dresses because they look oh so good on them.
Disclaimer: Although we are finance professionals, this is not professional advice. Talk with your consultants before making any decisions. Your decisions are yours alone.