Thinking about wealth, we must think about what we have – what is actually ours to keep. I read a newspaper piece this week about the North American saving rate and it is not good; it is less than 5%. The wealth we can actually keep must come from that 5% therefore most of us don’t have much wealth. In addition, our banks want us to invest that money with them at basically zero rate of return thus we would have to save for 20 years to have even one year’s worth of our income!
If we look deeper into the 5% we can see that the 5% is not what most of us save because the big savers, the rich folks are averaged into that percentage. I would guess that for most working folks in North America are saving less than 2% and are therefore one paycheque from broke. Once again, think about having to save for 50 years to have only saved a single year’s worth of income. There has to be a better way – and there is!
When I started to think about writing this post, I did some research and began to realize that in our society we don’t speak that much about wealth but rather about income. We seemed to be obsessed with how much salary people make rather than wealth as if the two are specifically linked which they are not. They could be linked but in reality it seems to be possible to spend more than you earn even when you earn lots.
So now you can see why I wanted to write this post – I have just explained my thought process – I want to talk about wealth rather than income and look at where wealth comes from. As I have explained in the past, I am not trying to explain complex investing ideas using derivatives to increase your investment results but only basic concepts of wealth and the good life it can bring for the majority of folks.
In order to create wealth (that we can keep) we need to save some of the income we make, no matter how much we make. I will use an example here that is not too extravagant – let us say someone making $14 an hour – not huge money but not minimum wage either. Now that amount per hour turns out to be $29,000 per year. This amount likely leaves the person with $2,000 a month after tax and guess what – you can live on that and save money too.
Let us now assume that this person has decided that she wants some wealth in the future and plans a saving rate of 20% of her income or $400 a month (actually only 16% before tax). She will of course only have $1,600 a month left to live on but that is her plan – let’s see how it works out.
Now $400 a month is quite a lot when you are living on $1,600 and a good budget will be required to get there but after 4 months she has an entire month’s salary saved, and after a year three months salary. That $5,000 nest egg is actually quite a lot if managed as an investment and she continues to save at the same rate. Investment returns and passing time will take care of generating wealth for her. For example, I have calculated a return of 4% per month on her increasing wealth (I built a little spreadsheet model to do that), which will result in $140,000 for her after 5 years. Additionally, her investment income begins to exceed her other income at the end of year 3!
I do realize that some will scoff at my suggested rate of return on investments at 4% monthly and I understand that point of view. That rate of return is not easy to achieve but not impossible either. We have all been conditioned into accepting bank rates of return on our investments which is designed to make banks rich and not us. Accepting bank rates of return guarantees poverty while saving on a salary – don’t accept it. Banks will use risk of losing your money as the threat to have you accept their rate which guarantees your giving up your life of earning to have a pittance at the end. I want you to do better – finance independence is the goal.
To summarize, you need to save to start your nest egg – we all do! Getting that nest egg started moves you in the right direction – toward wealth and financial independence. Turning that nest egg into wealth will only require two more ingredients; your rate of return and the passage of time. As we all know, the passage of time happens automatically so you are left with only having to manage your rate of return. I also encourage you to not accept the bank’s rate of return as it will make you poor. You can do better, much better and I will write another post right away to illustrate how it can be done!
So the road to wealth is simple – a saving plan to start a nest egg and a proper rate of return – time takes care of the rest and we are all given exactly the same amount of time! Let’s do this!
Take the first step and use a budget to get saving on a nest egg to start with. It doesn’t matter how small but at least something so you can look at the amount and think “That is mine”! Adjust your wasted spending into saving. Once you have your nest egg, come back to my next post and we can talk about how to generate the rate of return that will turn that nest egg into your financial independence. In that post, I will explain where good returns can be found and how your can use “turnover” to really ramp up your returns and your rate of building financial independence.