Building wealth is not a linear function, it’s exponential. It starts off slow then, provided you don’t go astray, should accelerate quicker and quicker as time goes on with a few bumps along the way. Let me explain how this works.
To get your first million dollars you are primarily relying on your personal exertion. That is, your earned income. You need to use your earned income to not only cover living costs but also have some residual cash flow which can be used for investment purposes.
It is difficult to build significant wealth with only your surplus cash flow as it requires a lot of discipline. Something which majority of people lack when it comes to their finances.
To give you an example, the average wage in Australia is roughly $89,000 per annum before tax which equates to roughly $69,000 after tax. If we assume you spend $50,000 per annum on living costs, and are very disciplined with the rest, this leaves $19,000 for wealth building.
If you take that $19,000 every year, invest it and can generate 6% p.a. on your investments, it will take roughly 25 years to reach $1 million dollars.
Now obviously there are a lot of variables in this formula and one would assume that over the years your income goes up giving you more available cash flow for investing but, for the purpose of this exercise, we will stick with these numbers.
So, getting that initial million dollars takes a lot of time and discipline. Most people never get there because a lot of people spend everything they earn! The only money that is saved is their mandated superannuation guaranteed contributions which often aren’t enough. But if you are an avid saver or a high-income earner you can definitely get there a lot quicker.
So now you have your first million, your second million will come a lot easier. You see, your money is your capital and your capital is your army. You can put that army to work to generate money for you which can also be invested. This is known as compounding.
All of a sudden you are in a position where you have not only your earned income but also the passive income from your investments.
Going back to our little example, if your earned income is $89,000 and you have $1 million invested generating 6% p.a. this gives you an additional $60,000 p.a. taking your total available funds up to $149,000 p.a. Now you can start building some serious wealth.
Assuming you still only deposit $19,000 p.a. from your earned income, and you let the earnings on $1 million dollars compound, it would take roughly 10 years to get your second million.
So, as you can see, using the same assumptions, it took 25 years to get your first million and only 10 years to get your second million. Can you guess how many years it would take to get your third million? Roughly 6 years.
This is not magic, it’s not rocket science, it’s just good old-fashioned compounding. There is a reason Einstein said that compounding is the eighth wonder of the world and this is the reason.
What I want you to take away from this is that the most important aspect to building wealth is to get started. Time is your friend when it comes to building wealth. Without time you can’t get compounding returns.
In my examples I have used pretty big numbers, but your goal might be to accumulate $100,000 and the same rules apply. It is going to be tough getting your first $10,000 but after that, every $10,000 increment on your way to $100,000 should be a little easier as you get some capital working for you.
So don’t procrastinate, get started now with what you have available and BE CONSISTENT WITH IT.
