The Power of Compounding
Our financial goals are only important if our health, relationships, energy, emotions, time, etc. are where we want them to be (or getting there). We don’t want to be “the richest man in the graveyard”.
First we have to differentiate wealth from financial freedom:
Financial freedom is having enough money so we don’t have to work to live our life. We can work because we want to but not because we have to.
Wealth is something we can have right now. Until we feel abundant, that there’s more than enough, we won’t feel rich (no matter how much money we have).
What’s wrong is always available, so is what’s right.
Tony Robbins
Money, freedom, wealth, abundance is always available, so is poverty, limitation, fear, etc.
Feeling wealthy is just a matter of realising how abundant we are and train ourselves to be grateful.
How to achieve your next financial goal
These are the 4 steps that we need to take to achieve our next level:
STEP 1. Make it a must
Usually we associate financial goals to getting lucky or we just set them as wishes. Until it becomes a priority and we start working towards it, we’ll never get there.
STEP 2. Accept responsibility
Stop blaming other people or your life conditions, take responsibility and go for it.
STEP 3. Add value to other people’s lives
The only way to become wealthy is by adding more value to other people’s life than anybody else.
STEP 4. Don’t get caught on the “tall poppy syndrome”
People around us may want to stop us (because accepting that we can do it means that they can too and that creates a conflict in them) but don’t let that happen.
The power of compounding
No matter how good we are, there’s a limit of what we can earn when we we trade our time for money. It’s when we invest (in others who are adding value) that we can trade our money for more money in the future.
Compounding happens when you invest money and reinvest the earnings with the initial investment. Money well invested generates earnings. That money plus the earnings generate bigger earnings that reinvested again and again compound and grow exponentially.
For example, investing $100 a month at your child’s birth at a 10% rate of return results in:
- $6,000 when the child turns 5
- $60,500 when the child turns 19
- $205,000 at age 30
- $1,5 million when he or she is age 50
- $4,3 million at age 60
- And $11,6 million at age 70!
Starting now is the key, because although in the beginning it grows slowly, in the future, each year makes a massive difference.
The best way to invest is in stocks, since they have long-term dependability (they have grown consistently on average over the years) and short-term flexibility (they’re much more easy to buy and sell than real estate).
The three bucket asset allocation (by John Templeton)
As humans, we tend to buy and sell based on our emotions, therefore it’s important to plan our investments and decide on the percentages in advance.
We should invest at least 10% of our income. Then we have to decide, depending on our needs and risk tolerance, how to split that into our three buckets:
70% to 40%
This is for low-risk, secure investments such as fixed income (bonds, treasury bills) and equity (insurance policies, our home).
Once we put it there, we don’t touch it.
30% to 60%
This is the bucket for investments that have a greater potential for growth and are more risky. Real estate, art, stocks, etc.
When we have a big win, we put 1/3 into the Security Bucket, 1/3 to reinvest and the last 1/3 into our dream bucket.
This are our savings for something fun, our dreams.
This also reinforces the behaviour of proper asset allocation by celebrating our victories and making it fun.
Pay yourself first
The best way to save money is to never see it.
If you struggle to save, make it automatic but we must always pay ourselves first. As soon as we receive a pay, 10% goes to those buckets and then we pay bills, rent, buy things, etc.
📚 Recommended reading
The Richest Man in Babylon by George S. Clason
It’s a wonderful story about a man who goes from being a slave to the richest man in Babylon. It teaches all the essentials of saving, investing and compounding with plain language. You don’t need any previous knowledge and because it’s short, simple and to the point is one of the best books to start reading about personal finance.
Check it out on GoodReads here.
Why people fail to become wealthy and how to succeed
This are 12 things that will make us fail at mastering finance:
- Not defining what wealth means to you
- Making wealth a moving target
- Defining wealth in ways that make it impossible to achieve
- Never starting
- Never making wealth an absolute must
- Not having a realistic plan
- Failing to follow through a plan
- Making someone else (a.k.a. “experts”) responsible for your decisions
- Giving up when faced with major challenges
- Failing to conduct life as if it was a business
- Allowing other people’s emotions to affect the implementation of your plan
- Not getting quality coaching
So, by doing the opposite we have a blueprint for mastering finance:
- Define what wealth means to you, exactly what will it take for you to feel wealthy
- Lock that definition firmly in place. Don’t keep raising the bar.
- Make sure your definition is achievable
- Create a plan that is achievable
- Make it a must for you by listing the reasons you must be wealthy
- Finalise your plan and work out the details
- Follow through on your plan by taking immediate action toward its attainment
- Make yourself responsible. Let experts coach you, but don’t abdicate your responsibility
- Don’t give up when the going gets tough
- Make your life a business, and expect a year-end profit
- Don’t let other people’s emotions control or cause you to deviate from your asset allocation
- Get good coaching
👉 Assignment
STEP 1: Decide how you’re going to allocate your assets.
I’m going to invest __________% of my income.
I’m going to split my investments in this ratio (for example, 50/50 or 60/40):
Security Bucket: __________%
Growth Bucket: __________%
STEP 2: Make it a must for you.
Write a paragraph or two about why you must be wealthy and what it will do for you, your family, your life. What will it give you? Who will you be? What will you do with your wealth?
STEP 3: Start making your plan.
Write down the steps you must take to begin or improve your investing strategy.
STEP 4: Never leave the scene of a decision without taking some action.
Choose two of the items you listed in STEP 3, and do them today. Make a note of what you did.
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