There’s a world of difference between having money and having wealth. Money is concrete. From its definition, money is a medium of exchange. It exists in the present: you have enough money to pay your mortgage, your car payment, your cable bill.
Wealth is something more abstract and forward-looking. Having wealth means you have the ability to sustain yourself over a period of time. Read as: wealth is the linchpin for ensuring a comfortable retirement.
Most of us earn money during our lives. This is the easy part. Turning money into long-term wealth can feel trickier. The good news here is that you don’t have to be a burgeoning Warren Buffet-type to get your investment strategy set up for success. Understanding just a few basic investment methods can put you on the road to building wealth.
Why savings accounts don’t always add up.
Some folks equate saving money with savings accounts, but these accounts aren’t geared towards growing wealth. Think about it. Put money into a savings account that you don’t plan on touching for 10, 20, or 30 years, and your money won’t even keep pace with inflation. According to the FDIC’s Weekly National Rates and Rate Caps, today’s average money market rate in America is 0.08 percent for deposits of less than $100,000. With inflation rising at approximately 2 percent year over year, socking away your retirement money into a savings account actually equals losing money!
Even crazier is the new technology that continues to crop up to get folks comfortable with growing their money. One app, called Digit, is designed to help people by saving money automatically. This sounds great until we discover that users don’t earn only a 0.20% “Savings Bonus” (aka interest) on their savings. The takeaway here is that, as with any approach to saving money, it’s important to know exactly what you’ll be using your savings for, and to make sure your money is reaching its full potential.
Where to put your savings instead.
Let’s turn to the stock market. Investing in the stock market yields various returns, and we all know the future is never guaranteed. If you take a short view of investing your money, the stock market may not seem like a big enough payoff. But over time, investing here will grow your money, and in turn, build wealth. Let’s talk about why.
The actual Warren Buffett was quoted, years ago in the aftermath of the financial crisis, as saying that investors should expect a return of 6 – 7 percent a year on stock market investments. Buffett gave this range despite the S&P 500’s long-term average over its history (1928 through 2014) of about 10 percent per year. Achieving a high single digit (or double digit) annual percentage return is what drives people to invest in the stock market for their retirement. Even erring on the side of a lower number, the result is a growth in wealth over the long haul.
By investing money into the stock market, your savings should be able to handily beat inflation over time. It seems like a no-brainer, right?
Benefits associated with investing, rather than just locking your money away in a savings account, can’t be overstated. If hearing 7 percent doesn’t get you excited, though, let’s run the numbers. You can easily calculate how long it will take for your money to double at this rate.
The Rule of 72
The “Rule of 72” is a simplified way to determine how long an investment will take to double, given a fixed annual rate of interest. By dividing 72 by the annual rate of return, investors can get a general estimate of how many years it will take for the initial investment to increase 100 percent.
For example, the rule of 72 states that $1 invested at 10 percent would take 7.2 years ((72/10) = 7.2) to turn into $2.
Thinking about this under Warren Buffett’s belief that you’ll receive 7.2 percent a year, that means if you invested $10,000 at 7.2 percent it would take about 10 years to turn into $20,000 ((72/7.2) = 10).
Okay, now what if you have your $10,000 in a savings account that (let’s be generous) is yielding 1 percent a year? It would take you 72 years to double! ((72/1) = 72). That’s 60 years of difference from investing!
Remember to invest for the long term.
At its core, the “Rule of 72” is just math. But it’s an extremely helpful guidepost to put the marathon of investing and growing wealth into perspective. Try running your particular numbers on your own, and factor in different interest rates to get a range for your wealth-building timetable.
For example, if you make 6 percent per year, how long will it take your $50,000 to reach $100,000? 72 divided by 6 equals 12, so at that rate your money doubles in 12 years. What about 9 percent per year? 72 divided by 9 equals 8, so at 9 percent per year, your money doubles every 8 years. Get it?
No one builds wealth overnight. Try turning your sights away from the short view of stashing money and towards the long view of growing wealth, and no doubt you’ll reap rewards over time. Using the “Rule of 72” will help you plot your personal timeline for just how long doubling your money (and amassing some wealth) might take.
Check Out: 4 Ways To Build Wealth – Think Pounds, Not Pennies