While your savings rate gets you to the playoffs (the race for retirement), making it grow will win you the championship of financial freedom! That’s why it’s crucial that you learn how to make money work for you. A great way to grow your money is to invest a portion of it in the market, whether that be through stocks, bonds, real estate, ETF’s, mutual funds, or something else you believe will gain a positive return.
Whenever investment professionals reference the idea of “making money work for you”, they are referencing the concept of investing your money in productive assets. It often takes minimal effort from you (the investor), once the money is actually invested.
Year after year, your accounts can grow exponentially because each year’s interest becomes next year’s principle, which then earns even more interest. Sound too good to be true? Maybe that’s why Albert Einstein described this compounding interest as the eighth wonder of the world.
Today, we’ll show you how to get there!
Step 1 – Live Below Your Means
Living below your means refers to spending less than you earn each month. For many, this is easier said than done. Today there are so many temptations and a plethora of loan options to choose from that make spending money you don’t have easy. However, it’s not a sustainable lifestyle and often catches up to people really quickly.
Step 2 – Save More
In short, by living below your means, you can increase your savings rate aka the amount of money you keep! You need to pay yourself first and the best way to do it is to start where you are. We recommend saving 10 percent or more of all you earn but recognize that some of us aren’t there yet. So it’s ok to start small and build up from there.
Step 3 – Put Your Money to Work
When you have savings, you can invest your money in ways that bring you a healthy ROI (return on investment). You can invest your money in sensible places, sit back, watch it compound and grow!
How to Reach Financial Freedom
Let’s run through an example of how one could achieve financial freedom in a decent amount of time. We’ll be using feasible savings rates and time horizons, to show the true power of increasing your savings rate plus investment compounding.
Billy is 45 years old and is making $100,000 per year. He decides that now is the time to start planning for retirement and can manage a savings rate of 12 percent or $12k/yr, which is double the national average.
If Billy wants to retire at 65, he’ll have about $500k, presuming a 7% annual rate of return (a conservative historical return on equity investments). Let’s even say that Billy does his homework on the investment and earns a higher rate of return – 9%. In that scenario, his savings grow to about $640k by the time he reaches retirement age.
While that 2 percent difference was not minuscule, let’s compare Billy to Angie, who started a bit earlier. At 25 years old when she was making $50k per year, she started saving at the national average rate of 6 percent (or $3k per year).
Over her savings span of 40 years, she earns a 7 percent rate of return on her investments. When Angie retires at 65 (staying at the same income and savings rate), she will have $620k, about the same as Bill who had a 9 percent return (2% greater than Angie), doubled income, and doubled savings rate.
However, let’s say Angie’s income does not stay stagnant, which is a reasonable presumption. Let’s also say that at 45, she makes the same amount as Bill and saves the same amount as Bill. Angie will become a millionaire at age 63 and can retire early, before the age of 65.
Thus, the keys to early retirement and financial freedom are to start early, increase your savings rate, and invest. For some of us, we’re already in Bill’s position at 45 years old with little to nothing saved.
The trick isn’t to look back and worry about the past, but move forward and begin to make the lifestyle changes needed to spend less, save more, and start investing. For others in Angie’s position at age 25, there’s a significant opportunity because time is on your side.
The keys and steps are the same: Strive for a high savings rate, keep increasing that rate as your income rises, and compound that savings over time. You can see where you’re at on the financial freedom journey. Plugin your own savings rate and predicted rate of return using this nifty tool from Networthify.
Once you reach financial freedom, don’t forget to live free and follow your dreams!