Sometimes it is easy to get overwhelmed by the big picture of financial independence. There are so many topics, nuances, and optimizations to be had. So, I thought it would be a good idea to write down small bits of the overall picture, and the lessons I have learned on each group. The first pillar of early retirement is savings. Therefore, it is important to discuss the urgency of saving, now.
Let’s take a look at two individuals, and their potential to create wealth. Mr FeelRich, and Mr. IsRich. Mr. FeelRich works at a fancy white-collar job, reels in a tidy $100,000 salary and saves 10% of his salary. That means he is setting aside $10,000 per year for retirement. Mr. IsRich however, lives a more conservative life-style and makes half of what Mr. FeelRich makes ($50,000). Because of the way Mr. IsRich lives, he is able to comfortably stow away $12,000 per year for retirement, or 24% of his salary. Each of these individuals continue saving at the same rate for two decades. You would imagine that the two men would be roughly $40,000 apart in their retirement accounts. However, compound interest plays a HUGE role in this. The long term average annual return of the S&P500 is 11.72%, by adjusting for inflation, that means the long-term average is around 8% (long term average inflation is 3.22%).
As you can see, compound interest gave Mr. IsRich over $51,000 MORE just in interest. Let’s look at one more example – Mr. Chunk and Mr. Payment. Mr. Chunk chooses to place $20,000 into an account immediately, but then never places another penny into that investment account. Mr. Payment, however chooses to pay $1,500 per year into an account (for a total of $30,000 principal in the account). Who do you think has more after 20 years?
Even though Mr. Payment contributed 50% more principal, Mr. Chunk has $18,000 more. This is why every single decision to save money NOW is worth more than a decision to save money later. Do not procrastinate on this, make compound interest and time your hard working friends.