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Wealth Creation: The Key Principles

Posted by Larry Doyle on June 13, 2013 9:44 AM |

It’s not how much you make, it’s how much you save.

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Many people in different businesses and within government across America do not like discussing or promoting personal savings rates but the simple fact is the path to financial security and wealth creation is navigated most effectively by embracing that key principle and a few basic tools.

These tools are not often discussed by those who would much prefer you spend, spend, spend so our economy can grow but that all too American style of living has simply led us down the ‘nonsense on cents‘ path of increased debt and often running in place if not worse than that in terms of building wealth. What are the keys for generating real wealth creation?

Many who regularly read this blog will be very familiar with these principles but I hope you might share this commentary with your younger friends and colleagues. Let’s navigate as John Hussman of the Hussman Funds lays out the Two Essential Elements of Wealth Accumulation,

Wealth is not acquired through addition. It is acquired through multiplication.

Very few fortunes have been made by adding up paychecks and overtime. Nor are they made through a huge one-time killing in the markets. Unfortunately, this is the path that many investors try to follow in achieving financial security.

According to statistical studies, two factors are most important in achieving wealth:

1. The number of years that an individual has been consistently saving and investing

2. The proportion of funds, on average, allocated to higher return investments

Simply stated, if your goal is to accumulate a significant amount of wealth during your lifetime, you must first save something, and then exercise some amount of control over one of two factors: the time horizon over which you compound your wealth and your long-term rate of return.

There are a preponderance of people willing to offer insights and wisdom on the second point highlighted by Hussman. Let’s focus on what I believe is the far more important key building block, that being the first.

The best way to increase the time horizon over which you compound wealth is simply to start saving and investing as early and consistently as possible.

Consider an investor earning a 10% long term rate of return. If the investor saves $2000 annually in a tax-deferred account (such as an IRA) for 10 years, and adds nothing for the next 20 years, the value of the portfolio at the end of 30 years will be $198,575. Although the investor committed a total of only $20,000, the account will have grown nearly tenfold.

Now consider an investor who fails to start early. Suppose that the investor saves nothing during the first 10 years, and then attempts to make up for lost time by investing $2000 annually for each of the next 20 years. At the end of 30 years, the value of this portfolio will be just $114,550.

The investor has committed a total of $40,000, twice as much as the first investor, but because the funds were not given as much time to compound, the investor retires with just over half as much wealth as the early bird. The higher the compound annual rate of return, or the greater the number of years to retirement, the more dramatic the effect that an early start will have on the ending wealth.

In regard to savings, Hussman provides equally sage advice in writing,

The key rule of saving is this. Don’t let your savings adjust to your spending needs. Let your spending adjust to your savings needs. 

It will help tremendously if you budget a certain amount of saving monthly, and make your investments first, as if you were paying a telephone bill. If you wait until all the bills are paid and all the spending is done, the result may be that you have nothing meaningful left to invest.

Make your monthly investments when you pay your other bills, and treat them as if they had a substantial late-payment penalty. The penalty for starting a savings program late really is enormous.

Financial security does not require extraordinary income or investment “home runs.” It requires, first and foremost, that you start saving and investing early, and add to your investments consistently.

These key principles and the discipline required to implement them may be increasingly challenging in light of the lack of growth in personal incomes currently but that fact makes them all that more important.

Navigate accordingly.

Larry Doyle

For those reading this via a syndicated outlet please visit my blog and comment on this piece of ‘sense on cents.

Isn’t  it time to subscribe to all my work via e-mail, an RSS feed, on Twitter or Facebook.

I have no business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets so that investor confidence and investor protection can be achieved.

  • fred

    Great post LD,

    Thought I’d try to add some more simple, generic value without making specific recommendations.

    Four things your mutual fund company or broker won’t tell you, 1)timing does matter, 2)costs do matter, 3)liquidity does matter, 4) dollar cost averaging only works over complete market cycles.

    Rather than explaining everything (I leave that to the reader to research), I will simply make some suggestions.

    Only use low cost INDEX ETFs that consistently trade over 1 million shares per day. Develop, and periodically revise, a longer term asset allocation for cash (money markets), fixed income (bonds) and equity (stocks, real estate, foreign stocks, etc.) investments that will achieve a return higher than inflation. Use long term, historical returns for the past 20-25 years or more. Do asset reallocation to your target %s every 1-2 yrs (duration of cap gains/losses matters) according to the criteria below.

    There are 2, very reliable, trading patterns in most markets you can take advantage of, 1)investing with the trend, and 2)price reversion to the mean.

    Ask yourself, how often will/do you periodicaly invest?

    Monthly (use a 20 day simple moving average), quarterly (use a 50 day simple moving average), yearly (use a 200 day moving average). Only invest in a particular asset class when 1) the slope of the moving average is moving higher, and 2) the current price is below the moving average. For example if stocks don’t meet the criteria, look to bonds, real estate or foreign stocks that investment period.

    Be patient, by definition, price returns to the moving average in a frequency equal to the length of time of the moving average.

    One final thought, you will need to save an amount equal to 15X your average annual spending (less extaordinary items, college, etc.) to achieve financial independence. Lacking sufficient funds, for ideas on thrift, visit a blog such as Mr. Money Mustache, there are plenty of good ideas on how to reduce spending and save money.

    Remember, always respect markets, they are ruthless and unforgiving if your not in their rythym.

    • LD

      Fred,

      Great stuff. TYVM.

  • Van

    LARRY

    THE WORST RECOMMENDATION I KNOW OF IS TO INVEST IN ANYTHING THAT PAYS IN DOLLARS.

    IT IS NOT NEWS WHY SO MANY OLDER CITIZENS ARE STILL WORKING, BECAUSE THEIR RETIREMENT HAS GONE SOUTH.

    I AM ACUTELY AWAY THAT WE ALL HAVE BEEN EDUCATED TO WORSHIP THE DOLLAR, THE RESULT IS…..400 PEOPLE IN THE USA OWN THE EQUIVALENT OF ALL THE WORTH OWNED.

    I ASSUME YOU KNOW HOW MANY EXIST HERE MINUS THE 400

  • larry Levin

    It would be interesting to see how the investing had done in purchasing power terms. for instance how many gallons of gasoline where invested over time and ho many gallons you have at the end, or food or even energy

    thanks Larry Doyle






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