It’s funny how our brain works with money.
For example, if I talk about saving $100,000, it immediately provokes criticism and cries of indignation. “A hundred thousand dollars! Who can save that? Do you know that life is expensive?”
But when it comes to spending, that mental block disappears. Spending $100,000 is seen as inevitable for most people, when it comes to things like renovations or maintaining a home over the years, for example.
So I ask you the question: where do you get this $100,000?
To the bank. And you pay the bank back, with interest. Over 25 years at a 5% interest rate, you will have paid back $174,482, and proven once again that it costs money that doesn’t belong to you.
What I propose? Reverse the process. You accumulate $100,000 instead of renting it from the bank. And instead of paying interest, you collect it.
I understand that even for a couple, accumulating a sum like $100,000 is intimidating.
As I wrote last year, saving $100,000 is by far the hardest part of the road to wealth, because almost every dollar comes from our income. Very little comes from investment returns.1.
As big as it is, $100,000 may seem like peanuts compared to $1 million – a sum many would dream of accumulating in a lifetime to approach the final years of their careers and the decades of retirement with confidence.
But it’s discouraging because it feels like $100,000 is only 10% of $1 million. In other words, even if we get there… 90% of the way to $1 million is still to go.
But I have good news: $100,000 is 25% of $1 million, not 10%.
For what ?
Because enrichment is a phenomenon that accelerates over time.
Let’s say both people in a couple save and invest a modest $14 a day each, which comes to about $10,000 a year. At 7% returns on their investments, it will take them just under eight years to reach $100,000.
But how long will it take them to go from $100,000 to $200,000?
About five years.
And to go from $200,000 to $300,000?
Less than four years.
And going from $900,000 to $1 million? A little over a year.
So the last $100,000 took eight times less time to accumulate than the first.
This is because the growth of a year does not only apply to the dollars invested by the couple that year. It also applies to all the dollars and growth of the previous years. This is the famous snowball effect.
It takes about 31 years to cross the million dollar line from zero by investing $10,000 per year with 7% growth per year.
The first $100,000 was reached after eight years. So after eight years, we’re about 25% of the way to reaching $1 million.
I can hear you from here: “Nicolas, stop your circus. Who can hope to obtain returns of 7% per year? You are not realistic! Your examples are far-fetched! They do not work in real life!”
No one knows what the future holds. But over the past 10 years, an investment in an all-in-one index exchange-traded fund that combines Canadian, U.S. and international stocks and bonds, such as the iShares Core Growth ETF (XGRO), has delivered annualized compound returns of 7.14%, after subtracting the 0.20% annual management fee.
All a person would have had to do to get that return is to periodically buy shares of a “growth” index fund, either on their bank’s own brokerage platform or through an institution like Wealthsimple or Questrade.
This person would not have had to follow economic news. Or predict the direction of interest rates. Or know the name of the governor of the central bank of Canada. Or seek to know what he thinks.
She wouldn’t have had to worry about Bombardier’s order book or Apple’s financial results. Or follow the (exciting) debates over the U.S. Federal Reserve’s decision-making. Or anticipate COVID-19, or the monster economic recovery that followed.
All this person would have had to do was invest regularly, rain or shine, in an internationally diversified index fund with low management fees.
And the beauty of an index fund is that it regularly “cleans itself.” Declining companies leave, while rising companies join. The fund evolves over time to reflect the state of the market. All without the investor having to do anything.
Very few people understand that when it comes to investing, the less you do, the better. This is one of the few areas where “lazy” people can expect to outperform “caffeinated” people.
No one knows what the future holds.
For my part, I prefer to discover it by accumulating financial assets rather than by accumulating debts.
And telling myself that the person who has $100,000 is closer to being a millionaire than they think.
Question of the week: have you made a habit of saving?
1. Read the article “Why the first $100,000 is the hardest to accumulate”