Nearly everyone wants to reach a healthy level of wealth so that they can have an enjoyable life in their golden years.
But what’s the biggest reason for becoming wealthy? For a select few it’s being involved with a business that really blasts off, either as a founder or early investor. Not everyone can find Microsoft, Amazon or Afterpay Touch Group Ltd (ASX: APT) early on in the growth journey.
Excluding those lucky investors who gain wealth from a single business, you might expect that the biggest reason for wealth is just generally the performance of your investments. Over the decades the average return of the market, represented by exchange-traded funds (ETFs) like iShares S&P 500 ETF (ASX: IVV) and Vanguard Australian Share ETF (ASX: VAS), has been 10% per annum.
We’re told how powerful the strength of the compound interest is. It’s certainly true, compound interest is an enormous financial force. If you start with $10,000 and add nothing else and it returns 10% a year for 30 years it will become $174,500. If it returns 12% a year it becomes $300,000. Just an extra 2% a year makes a huge difference.
But people don’t just invest one lump sum, they invest throughout their life. Unless you’re able to replicate the returns of Warren Buffett in his earlier years, the biggest contributor to your wealth will be your savings rate. The stats can show it.
Let’s say someone, over 30 years, invests $1,000 a month ($12,000 a year) and returns 12% a year – it turns into $2.9 million. But compare that to someone who invests $2,000 a month ($24,000 a year) and returns the market average of 10% a year – it turns into $3.95 million.
Unless you’re able to substantially improve your investment performance you are much better off focused on improving your savings rate and earnings to help your wealth.
Obviously, if a person can make returns of 12% per annum and save a lot more will be better off.
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Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of AFTERPAY T FPO. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.