Gen Y Finance Guy, a GenFKD friend in the fight for financial literacy, stops by to drop some knowledge on the respective impacts of a saving and compound interest rates on personal wealth building.
Most people assume that the Compound Return on your investments is the most important variable in rapid wealth building. When in fact, it’s actually your savings rate that will determine the speed at which you build wealth, and I have the math to prove it.
Compounding is amazing, no doubt about it, but it takes decades to work its magic (unless you’re already wealthy).
From my vantage point there are two ways to become wealthy:
1.) The Slow Way (low savings rate, average market returns)
2.) The Fast Way (high savings rate, average market returns)
Which one do you prefer? This kind of seems like a no brainier, right? Our natural unfiltered response is likely “The Fast Way.”
As my grandfather use to say “we want to get there immediately, if not sooner.” There is no right or wrong answer and you may come to find out that “The Slow Way” is the right choice for you, and there is nothing wrong with that.
Before you answer, you need to know that “The Fast Way” is going to require more HUSTLE, DISCIPLINE, and FOCUS.
YOU need to ask yourself if you are willing to pay the price to ACHIEVE substantial wealth in 10-20 years instead of 40 years plus. Are you willing to be a non-conformist and go against the crowd?
Are you willing to live your life like most won’t for a couple years, so that you can live the rest of your life like most can’t?
There is already plenty of content that covers how to get rich “The Slow Way.”
It’s not how much money you make, but how much money you keep. – Robert Kiyosaki
The fast way vs. the slow way to wealth
In order to convey the importance of the Savings Rate I am going to use math and a few examples of different types of wealth builders.
4 different wealth builders
-Steve: Saves 5% of his income and would be considered the average American.
-Adam: Saves 10% of his income, which many financial planners tout as the sure path to wealth by age 65.
-Sally: Saves 15% of her income.
-GYFG: Saves 50% of his income and would be considered an aggressive saver.
There are six assumptions that I am going to hold as constant (to keep the illustration simple):
1.) Taxes will be assumed at 25%.
2.) Duration will be 20 years
3.) The wealth builders’ savings rate defined above will be the same in all scenarios.
4.) A historical market return of 8% for Steve, Adam, and Sally. GYFG will get 0%.
5.) Static income (meaning no raises)
6.) CAGR = Compound Annual Growth Rate = Compound Return
In the proceeding illustration, my goal is to show you the spectrum of results that will hopefully drive home the importance of your savings rate when it comes to wealth building.
One final note before we continue. There are unlimited permutations to this, but I chose the assumptions I did to keep this exercise on point, and to prove to you that your savings rate has more power than you may have realized.
Notice that we assume that GYFG earns a compound annual growth rate of ZERO. I hope that many of you would agree that this is an extreme assumption and is probably unlikely, but it allows us to really isolate the importance of savings rate by itself. Notice how in all cases, even after earning 0%, GYFG is able to accumulate more wealth than all of the other wealth builders. And this is over a 20 year period of 8% compounded returns for the other three wealth builders.
Over the 20 year period GYFG was able to save $750K. In the green highlighted section (table above) I have provided what the returns would need to be in order for the other wealth builders to keep pace with GYFG, given their respective savings rates.
-Steve would need to earn a CAGR of 21%.
-Adam would need to earn a CAGR of 15%.
-Sally would need to earn a CAGR of 11%.
I don’t know anyone who has consistently earned these kinds of returns, outside of the world’s best investors (hello Warren Buffett).
Curious what happens if GYFG also earns the historical market return? His wealth jumps from $750,000 to $1,716,074.
I hope this article helped you realize the power your savings rate has on your ability to build rapid wealth. Let’s also clear the air…You have absolutely no control over investment returns, but you do have control over your savings rate.
Did this surprise you? Will you think about your savings rate a bit differently? Maybe make it a priority?