Apr 132020
 

Long term planning

There were three events that had a profound impact on my financial life. They helped me realize that when you choose to invest, you are not just picking up a new hobby or side hustle. You are actually choosing a lifelong career – a future. Much like a marathon, investing is for the long run. 😎

So today I’d like to start with part one of three – compound growth and long term planning. Compound interest is one of the most profound discoveries in human history and has the potential to change lives. Even Albert Einstein once declared it to be the most powerful force in the universe. 🙂

 

It all started in high school

Financial education typically starts at home. I learned from my parents how to be a net saver. But grade 11 is when I really began to think about money and wealth.

It was the early 2000s. Linkin Park was on the radio. MSN Messenger was still relevant. I was 16 years old. My school offered Economics 11. Out of all the elective courses this one seemed to be the most practical so I decided to enroll. That might have been the single best decision I’ve ever made. 🙂

One day during class we learned about compound interest. The textbook demonstrated the impact of time using an example with two people. I forgot their names, but let’s call them Stacy and Chad.

  • Stacy invests $2,000/year starting from the age of 19.
  • Chad also invests $2,000/year but starts 10 years later at age 29.

By the time they both retire at age 60 Stacy is a millionaire, while Chad only has $402,000. The book included a helpful table like the one below.

I couldn’t believe it. How can ten years make such a dramatic difference? I went home, copied the figures into Excel, and double checked the math myself. Sure enough, Stacy would end up with 2.5x as much as Chad. Furthermore if Stacy had only invested for the first 5 years and then stopped contributing to her account altogether, she would still end up wealthier despite investing only a fraction of the amount Chad had to save up. Here’s what that table looks like. Wow. It’s all because she started earlier.

This seemed unfathomable to me. In my naive teenage mind I had always thought that you can’t succeed on your own unless you work hard. You will never have good grades unless you study. You will never play in the basketball tournament unless you attend practice after school. You will never pwn your friends at GoldenEye 007 unless you have blisters from the N64 controller. But the economics lesson made me question everything. It turned my entire worldview upside down.

I used to believe that in order to accumulate more wealth you had to study harder in school, land a better job, and save more income. But Stacy proved there’s an easier way to achieve the same end result. She didn’t need a higher savings rate than Chad to retire with 2.5x his net worth. So the only thing you have to do to retire with more money is start investing early. That’s it. 🙂

This idea of additional success without working for it created a paradigm shift in my way of thinking. I realized that it actually is possible to get something for nothing. From then on I tried to work smarter, not harder.

The only disadvantage of saving earlier is you have to delay your spending. But Stacy’s early start rewarded her with an extra $673,000 at retirement. So I think that far outweighs the downside of spending a little less in early adulthood.

After this epiphany in economics class I decided to follow in Stacy’s footsteps and invest as early as possible. I didn’t know what profession I would end up in. I wasn’t sure how much income I would earn. But I was certain that whatever money I do make, I would put away at least $2,000 a year.

 

Saving my first dollar

Instead of finishing a multi year university degree I took a one year graphic design program so I could have an early start to retirement like Stacy. I landed my first industry job at age 20, and I’ve been saving and investing every year since then. 🙂

Starting early doesn’t only apply to personal finance. In business starting early gives you that first-mover advantage. Generally speaking, developing good habits at a young age is much easier than acquiring them later in life. The more recipes you know the easier it is to learn new ones because your skills and techniques compound just like with investment interest. Watching your diet starting at age 19 rather than 39 will reduce the chance of health issues throughout your life.

The longer you put things off the harder it is to maintain a healthy body, healthy finances, or healthy relationships. So compound growth inherently exists in many aspects of life. I was very fortunate to be introduced to this concept in high school.

 

Rice and chess

To end this post I will leave you with a short parable to demonstrate how our linear brains tend to underestimate compound growth. As the story goes, the inventor of Chess presents the game to the Emperor of India, who is so impressed he offers the inventor any reward he wants. The inventor asks for a single grain of rice on the 1st square of his board, then two grains on the 2nd, four grains on the 3rd and so on. The Emperor agrees thinking that should be okay since there are only 64 squares on the board.

But he later becomes furious when the court treasurer reports that by the last square, the total would be 18,446,744,073,709,551,615 grains of rice, a pile larger than Mount Everest. This is why exponential growth can lead to results difficult for people to comprehend.

 

 

____________________
Random Useless Fact:

Full service restaurants saw a 79% decline in transactions at the end of March 2020 due to the pandemic.

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beth
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beth

I thought this was a great post and I wished I could send it to younger me. I had cut the URL to send to my young sons and their wives but then I got to the random useless fact and was offended by the meme so I won’t be sharing it with anyone.

Khan
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Khan

Glad you called him out on it. I enjoy reading his posts but sometimes the ‘jokes’ at the end put me off

rich_not_so_rich
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rich_not_so_rich

The fact that the random useless fact is so real is the sad part… I am 100% for equal rights and equally sharing ones expenses.

AlW
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AlW

Don’t be so sensitive for the random useless fact. Life it too short to take super seriously – none of us are getting out of here alive.

The compound interest table I always loved, however equally as important to growing compound interest is the effect of taxes and other fees on the return rate. You throw a 1-2% management fee and a 50% tax on what Stacy and Chad are pulling down there for returns and it’ll drastically kill their returns. Investing in tax sheltered accounts and reducing carrying costs/fees are very valuable to growing ones portfolio.

MoneyMaaster
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The compound interest example is what hooked me too. Only difference, mine was from the wealthy barber – not a textbook in school.

Cheers

Tyler
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Tyler

Sounds like I should’ve taken Econ 11. I might’ve learned about the effects of compound interest at 16 instead of at 30 lol. Like you said in an earlier response though, pain + reflection = progress

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