Fortune Magazine is featuring 10 Rules for Building Wealth. Rule number one is something I wish I had known years before I did: Start early.
By starting early and saving a negligible amount per month, thanks to compounded interest and earnings on earnings, you can end up with more money than someone who starts later. The example provided by the magazine tells the story:
Employee A starts putting away $100 a month when she’s 22. Her money grows at 8 percent a year, and after ten years she stops contributing – and lets her stake grow. Employee B waits until he’s 32 to set aside $100 a month, also growing at 8 percent a year, and he keeps it up until he hits 64. When they both retire at 64, she will have $234,600, and he’ll have only $177,400.
This is the Butterfly Effect. Small changes can have drastic consequences when time is allowed to pass, and the difference is more pronounced with more time. But inflation is as powerful a force as compounding, and when you look at the numbers after taking inflation into account, the differences are less drastic. This is why you have to think beyond the standard personal finance advice. You hear often that all it takes is a little contribution each month to make you a millionaire… some time in the future.
By the time that happens, one million dollars will have the same buying power of “only” $400,000. Yes, it’s more than you would have if you hadn’t been saving, but don’t be fooled by the catchy “millionaire” title. By the time you’re a millionaire, everyone else will be, too. It’s not quite as special when you look at it that way.
Subscribe
Starting an investment plan early on was a key to my own personal wealth building.
I started at age 23, investing only $25 biweekly. I had $25 deducted from my check every payday. I never missed the $25 and it was fun to see my investment statement at the end of the year.
I put in $650 over the course of the year and by the end of my first year of investing that $650 magically turned into $1500.
As every year has rolled by the compound interest effect has kicked in (I am now 37) and that measly amount invested every month has skyrocketed into much more – I am on track to be truly financially free by age 45.
I do advise any “newbie investors” patience is a key to succeeding with investing.
Here is a brief story of a case where I jumped out too early:
I was holding a tech stock that plummeted to around $1/share and that was down from close to $100/share.
When the tech stock rose to $4/share I dumped my entire holdings.
That’s the wrong time to dump shares. The company was still showing some solid reports but I let emotion rule and got out way too early.
That stock recently hit $40/share. Had I continued investing in that very same stock at the rate I once was I could have had $800,000 right now.
Remember patience, remove emotion and some basic knowledge of reading annual reports etc. will build wealth with minimal investing.
I always thought some of these examples of how to save early to become a millionaire are misleading. I always cringe when I hear you can become a millioniare in 30-40 years, because as you said the value is significantly less in the future (actually $250,000 if you use 3.5% interest in 40 years).
Also, when these examples use a fixed contibution for 40 years, it still ignores inflation and wage growth. I love the example of if you contributed $2,000 in your early twenties and are 65 today, you could have been a millionaire. Unfortunately, $2,000 a whole lot more money 40 years ago then it is today. If these examples where realistic, the contribution should be adjusted for inflation as well (and the results would be a whole lot different).
I have writting up a few examples at:
http://www.myfinancialawareness.com/Topics%20Financial/Myth%20-%20Don%27t%20Wait%20Save%20Early.htm
That is not a valid example of the butterfly effect. Look it up.
Sam: According to Wikipedia, the principle of the Butterfly Effect is, “Small variations of the initial condition of a dynamical system may produce large variations in the long term behavior of the system.”
Yes, it’s a term generally applied to meteorological theory, but the concept is similar, and there’s no reason it can’t be applied to other “dynamical systems.” Small changes at one point affecting large changes at another point is the basis of the thought. Compounding interest and appreciation may not be the typical application of the term “Butterfly Effect,” but it’s easy to extrapolate.