No matter you want to get financially independent or just want to accumulate some wealth, you simply can’t avoid tightening your belt and start saving. Unless you’re lucky enough and you’re already sitting on a big pile of cash, your savings will be the most important element of your portfolio for many years. In this article I’ll show you why.
Previously I’ve already demonstrated the importance of saving rate and how even a few percent of extra saving per month can speed up your journey towards financial independence. If you haven’t done so, I invite you to read it:
Talking about saving rate already presumes that you already save on a regular basis. Without this, it is extremely difficult to improve your financial situation. As mentioned before, this will be the main fuel of the engine of your portfolio for many years.
Every Little Counts
Let’s say you save EUR 500 per month or EUR 6,000 per year and the long term return on your investment is 7% per year. The return of the first year will be EUR 420.
This is even less than 1 month of saving. Looking at such numbers is the point when many people get discouraged. Don’t be and keep on reading!
It’s true that the return of the first year will be very low. But this is the reason why saving is so important at the beginning. The EUR 6,000 you save per year is over 14 times more than the return. In the early years this is still the biggest addition to your portfolio.
In year 2 the return will be EUR 869. Something starts to happen. It’s already more than your monthly saving. It’s like you got an extra month without any extra effort, just the benefits. Your saving is still the most important element of your portfolio, so keep on adding that extra money each month!
The real milestone will happen in year 11. Your investment returns will exceed your savings! That small snowball you started to roll years ago is becoming an avalanche.
Of course it doesn’t mean that you should stop saving, but from here onward it won’t represent the main source of wealth booster. Your portfolio is now growing twice as fast, and due to the compounding effect it will speed up even faster before you notice.
The below table might make it even more clear:
Keep in mind that you will never get to this point without saving. Not even if you had much more money to start with.
How About a Wealthier Start?
The above example assumes that you start with zero money, but save regularly. But what if you have some cash sitting on your account? Let’s say 8 times of the annual saving, so EUR 48k. Can you just invest it (plus its returns) and forget about saving?
Well, under the same conditions, the return of the first year will be EUR 3,360. This worth more than half year of saving if you compare it to the first example. In addition, due to the compounding effect, the return will be higher year by year.
But what will happen on a long term? This chart tells it all:
After around 12 years, the value of the saving portfolio has exceeded the non saving one and from there onward the gap between them is getting bigger year by year.
Of course there is an amount of money that would generate enough returns that would be enough for the rest of your life, but most of us is not lucky enough to be in a position to have it from day 1.
For the large majority of people the most achievable path towards wealth and financial independence leads through saving and investing. This is what I am doing as well and this is what this blog is about. Join us in our journey on the road to one million!
Disclaimer: This post or any other information on the site is not intended to be and does not constitute financial advice or any other advice. I am solely sharing my idea, plan and progress on financial independence and early retirement.