Monday, January 25, 2010

Making Millionaires Out of Average Joes

Sometimes that magic million dollar mark can seem out of reach. I mean – you earn your $50,000 paycheck, and by the time you’ve paid the mortgage, the car, the kids, the wife / hubby, the insurance, the rates, the groceries, the renovations (this list could go on for a while) there is hardly anything left for yourself – let alone to invest!

The good news is that a million dollars and beyond is actually not out of reach, and you can achieve it with less effort than you’d imagine. You don’t even have to do anything crazy like sell your grandmother or walk across hot coals – you just need to know how to use a simple mathematical tool called “compounding”.

The Eighth Wonder of the World

Compounding – a wise man once described it as “The eighth wonder of the world”. You may have heard of him – his name was Albert Einstein. Others have said that the moment you understand it your world will never be the same again. But, what is it exactly?

Compounding is when you have some money, earn a return on that money, and then re-invest the returns and do not take any out. This has the effect, over time, of earning “returns on your returns”. Now it can start out slow, like growing grass, and this is why many people give up. But with time these small returns grow exponentially, and your grass instead grows into mountains.

Let’s check out an example with a young man we’ll call Jake:

Jake used to buy two coffees and lunch at work every day – costing him around $15 a day. Over lunch one day I pointed this out to him, and also pointed out what would happen if he invested this money instead. Jake was dumbfounded - he vowed right then to change his ways. Over the course of time Jake earned a 15% return on his money – let’s see what happened:

In his first year Jake saved $5,460, but had $5,851 in his account after his returns.
In his second year Jake had saved $10,920, but had in his account $12,643 after his returns.
After five years Jake had saved $27,300 of his own money, but actually had $40,301 in his account. As you can see, the gap between his own money and investing his own money was starting to widen.
After 10 years, Jake had an amount of $125,223 in his account (the grass was really starting to grow).
After 20 years Jake had a nice $681,243.
But this is where the real magic happened (remember those mountains I told you about). In the next five years Jake earned a massive $794,562 from his investments, bringing him to a total of $1,475,805. Jake was officially a millionaire, and all because he started bringing his own lunch to work.

By the way, Jake didn’t even miss the $105 a week by the end of this – it left his account first and he didn’t even see it. And he can now afford to buy any lunch he pleases, whether he wants to continue working or not.

How Can I Get Started?

As you can see the really magic happened in the last 5 years – so I can’t stress enough that the longer you delay the longer it will take you to get there. Now of course you do need some money to invest. If you haven’t got any (or even if you do) the best way to get started is to “pay yourself first”. Set up an automatic transfer into another account so you never see the money, and set aside at the very least 10% of your net income each pay. There is a great book called “The Richest Man In Babylon”, which describes this perfectly. Go for it! A regular person really can become a millionaire, and that makes me happy.
By Dave McLachlan

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