The Surprising True Source of Wealth Creation (That You Probably Already Have)

by Eric Roberge CFP on 9 May 2014 0 comments

What is the first thing that comes to mind when you hear the word "wealth"?

I may not be able to guess what that "thing" is, but I can tell you what it isn't… "save"… or any variation of the word.

We have done a great job in this country of hiding the true facts about how people really grow their wealth. And the reason is obvious. Saving is boring. Plus, it certainly doesn't make big retailers and other companies any money. So, from a purely profit driven standpoint, why would anyone want to show you how good saving habits might actually help you financially?

Let's take a look at some simple math for a minute.

Some Simple Savings Math

Do you know how long it takes an investment to double with a guaranteed 10% compound rate of return? It takes over seven years.

So how long does it take your money to double if you have been saving $100 per month for seven years (you now have $8,400) and you continue to do so? Seven years.

Hmm… that's interesting.

If you invest $8,400 today at 10% compounded annually, you will have $16,369 in seven years. However, if you have $8,400 in the bank making 0% and continue to save $100 per month for the next seven years, you end up with $16,800.

Now there are certainly other factors to consider before you choose to pull all your money from the stock market and stick it in a bank account, but for now let's keep this simple. The truth is that you won't find a "guaranteed" return of 10% anywhere these days. But, if you are capable of saving just $100 every month, you are guaranteed to grow your assets, and therefore, your net worth. (See how saving grows your net worth using this simple net worth calculator.)

The Rule of 72

Let's put this into perspective. Investments follow a very simple rule. It's called the rule of 72.

This rule states that you can figure out how long it will take an investment to double by simply dividing 72 by the expected rate of return. For example, if you expect to receive a 7% rate of return on your money (compounded annually), then your money will double in 10.3 years (72 divided by 7 = 10.3).

This also works the opposite way. If your goal is to double your $20,000 in 10 years to make a down payment on a home (and not adding any additional savings), then you need to find an investment with an expected rate of return of 7.2%. (Still not getting it? Check out this short Rule of 72 video for further explanation.)

Although the rule is simple, finding a decent rate of return is the challenge. You don't really have much control here. However, what you do have complete control of is your spending and savings habits. It's this often-overlooked area that is the source of growing wealth over time.

One reason that people may not focus on saving is because it's not sexy, and it cuts into their spending. Clearly, if it was simply a choice of choosing to invest your money and letting it grow on its own or using your own income to save $100 a month, the answer would most likely be to take the investment route.

The problem is that when the stock market does well, people start letting their investments do all the work, forgetting that good savings habits can have a huge positive impact on personal finances. Plus, everyone likes the instant gratification of being able to make purchases with their hard earned money. Saving doesn't quite create that same feeling.

5 Easy Ways to Save More

Unfortunately, the stock market and other investments don't always rise. So, rather than sit back and complain that the stock market isn't growing your money, why not set up a system for saving each year? Here are five ways to do just that! (See also: 6 Ways to Get Paid for Saving Money)

1. Use Your Tax Refund

Your tax refund is a great place to start. Although not guaranteed, the average IRS refund so far in 2014 is over $3,000. Even if you just take a third of that money and save it, you'll have $2,000 right now!

2. Make a Plan for Your Company Bonus

Company bonuses typically come but once a year, and when they do, they hit your paycheck all at once. How about taking some of that hard-earned money and moving it into a savings account before it "accidentally" gets gobbled up by the gremlin that lives in your checking account?

3. Take Advantage of Your Company's 401(k) Match

Your company may be willing to give you extra money just for contributing to your 401(k). Check with your HR department to see if your company offers this match. If you are not currently taking advantage of this, do it immediately. Here's why: Let's say you make $75,000 per year in salary. If your company matches 100% of your contribution up to 3% of your salary, all you have to do is contribute $2,250 this year and you will receive another $2,250 for free! That's 100% gain on your money… unheard of!

4. Sell Your Stuff Online

Sure, this one sounds complicated if you haven't done it before, but it really isn't that bad. You may have a ton of quality items in your attic that you just don't need. You know what they say, "one person's junk is another person's treasure!" Do you have an extra Apple product lying around? Check out Gazelle to see what you can get for it. Getting rid of just a few things might just add up to a decent chunk of money to… yes… save!

5. Set Up an Auto-Transfer

One great thing about technology is that it makes monotonous tasks quite simple. By simply logging into your bank account online, you can set up an auto-transfer from your checking to your savings account each month. This way, you don't get tempted to spend that extra cash sitting in your checking account, because it has magically disappeared and reincarnated as money you have saved for the future!

The bottom line is that it isn't up to the stock market to make you wealthy. Sure, it can help support the growth of your money over long periods of time, but it all starts with you and your saving habits. Take advantage of your working years by setting up specific annual savings strategies. This, combined with an appropriate investment plan can take your finances to the next level!

Have you seen your net worth increase because of your efforts to save more? Please share the wealth in comments!

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