I am always a bit tickled when people constantly hit me up to ask me about which stock to invest in, or which new-fangled asset class to invest in. When they hear my response, they are always either disappointed, a bit upset or sometimes are a bit amazed 😊. Of course, we always read in the media about people who made money investing in something or a warren buffet article on how he invests in only 7 stocks, or about this entrepreneur who is now a billionaire. All of those people are for most parts outliers. We don’t often read about how ordinary people like you and me created wealth.
Creating wealth comes down to three things
At the heart of it, creating wealth depends on 3 things:
- How much you save?
- How much of that savings you invest?
- How/where you invest the money?
Everyone focuses on item 3 and gets excited about item 3. There are a couple of reasons why – first off, most, if not all of my readers are people who earn more than they spend – sometimes by quite a bit. So they are not interested in investing time and energy thinking about 1 or 2. You could argue they don’t need to. But I will explain why it is important in a bit. Second, its way more exciting to talk about where to invest vs something boring and painful as how to save money.
In my opinion, items 1 and 2 are the most fundamental drivers of building wealth. Read on to see why.
How much you save
The first and most fundamental step to creating wealth is to make sure you save money – the gap between your earnings and your spending. The higher that is, the higher you are going to grow your wealth. But if you are someone who is already saving money, do you need to worry about this? Well, let me explain it this way. If you can save an additional $100-$200 a month by making some permanent cuts to some expenses, its one of the most powerful ways to increase your wealth. Why is that? One, you get to take that additional savings and invest it. Two, the amount of money you need to live has permanently reduced and so the amount of you money you need is lesser. In order to invest more money, you have to first save that money 😊
If you save $100 a month extra for 10 years and invest it at a average 7% return (more on that rate of return later), you will have $16,580 at the end of 10 years! Using the same return assumption of 7%, if you save $200 a month extra for 10 years, you will have $33,160!! This is the power of compounding of small, incremental numbers.
Obviously cutting your expenses to increase the gap can only go so far once you have truly optimized everything. Increasing your earnings is going to be the driver to superpower your savings. I will admit I dont talk about this enough in my blog and I recognize I need to write a seperate article on this.
But please don’t ever dismiss re-looking at your expenses and optimizing them as I have explained in one of my earlier articles ‘Lets Marie-Kondo those expenses’. The other article I would encourage you to read is the one I wrote on ‘Less is more’ where I would like you to challenge your paradigms on the expenses you currently have.
Ultimately people measure this as a % of your income you save. If you save only 1% of your income on a regular consistent basis, it indicative of the fact that your expenses and income are almost equal and its going to take a LONG time for you to save enough money. On the other hand, if you consistently save 10% – 20% of your income, you are on the path to a normal retirement horizon. If you are like the people from the FIRE (Financial Independence, Retire Early) community who save 50% – 70% of their income, then you are on path to retire in a pretty fast time period. So measuring your savings as a % of your income is a good heuristic to know if you are doing well on this.
How much of that savings did you invest?
Just because you saved does not mean you invested it. You may have been saving for an expense in the future. A vacation maybe? Or a car? All of those are fine. But if you spend it something that does not create wealth for you then obviously you are not going to get the benefits of creating wealth. But btw, spending money you saved on something that brings you joy – for eg. a vacation that will create long-lasting memories is a different form of investment that cannot measured in monetary terms. So as long as you are intentional about this, its perfectly fine. However, if all of your savings are spent on these type of items without the ability to create wealth, then you are obviously not going to create wealth.
I have explained in more detail in one of my articles ‘Creating long lasting wealth’ about the idea of buying assets that create income for you.
The key here is to have a consistent habit of investing your savings over a period of time. This is the single biggest driver of creating wealth.
How/where do invest the money?
Now, lets talk about the part that excites everyone. Warning to everyone – what I am about to say is going to disappoint you if you are thinking I am about to embark on advice on some juicy investments that promise you 25% returns each year.
Where to invest?
You don’t need to be a wall street genius to know where to invest your money. This is the premise of this blog. Keeping it simple, and investing in long-term, broad-based index funds for example is perfectly fine. Author J.L. Collins propagates this in his book ‘The simple path to wealth’ . I explain this in my article on ‘Active vs passive investment in the stock market’. Doing this consistently over a long period of time will give you on average 7% returns in the long run in the US. (This is based on historical stock market returns and past performance is not a guarantee of future performance but in my mind is a good reference point) And honestly, while for some people 7% annually over a period of time might sound boring, that is good enough for you to create wealth. As long as you keep doing point 2 above.
Why not invest in higher return yielding investments so you can get rich sooner? As you have heard me say this in my blog – if you understand an investment well, and you have sought the advice of people who know what they are talking about and then decide to invest in something – that’s perfectly fine. If you believe in the long run prospects of Bitcoin for example and have done your research – go ahead. That’s your personal investment philosophy. But I always caution people of get-rich-quick schemes.
Building wealth, is a slow, steady process.
But ultimately, don’t get super-fixated on this part of the question – obviously putting all your savings in a checking account earning below 1% returns is a bad idea. You don’t want to do that.
How to invest?
When I use the word ‘how’, what I mean is your behavior and style of investing. This is probably a much bigger deal than where to invest. I am a proponent of being a long-term investor vs a day-trader or a speculator for the average person like you and me. That means – don’t try to time the market and dance in and out of the market. Doing that has known to be a wealth-killer even for the most savvy, smart investors. So just invest the money consistently, and don’t mess with it too much. Finally, remember the saying – “Time in the market is more valuable than timing the market”.
Concluding comments
I want to conclude with the comments I made in the beginning of this article. Popular media celebrates the story of a Jeff Bezos, Warren Buffet, Bill Gates or Mark Zuckerberg who started companies and became multi-billionaires. Starting a business and if that business becomes successful is how the richest people on this planet created wealth. But as I mentioned they are outliers. While its great to seek inspiration from them, don’t get fixated on the WHERE they invested as I explain in this article. Focus on the other questions and if you follow that well, there is an extremely high probability that you will create wealth.
Thank you for reading and I wish you luck in your financial journey!
Disclaimer: I am not a financial advisor and all the information in my articles are from my personal experience and are for informational and educational purposes only. Please consult with a financial advisor or CPA for professional advice.
