The Joy of Compounding
One of the latest trends on social media seems to be young adults expressing their frustrations about life’s challenges, often attributing them to their parents or grandparents. It is understandable, considering many pursued degrees like gender studies, philosophy, creative writing, anthropology, or art history. Professors and administrators misled them about the value of these degrees, and now they face the realities of the job market. Schools and parents do such a poor job of teaching financial responsibility that many students lack the critical thinking skills to see through this deception. They leave school saddled with debt and learn their degree will leave them there for years, if not decades, to come.
It is crucial for young adults to understand that the job market is not a utopia where you land your dream job with a comfortable salary right after college. Instead of dwelling on these challenges, it is time for them to embrace resilience and adapt to the realities of the world.
A Little Resiliency, Please
One brutal awakening for today’s youth is that no one but you cares about your feelings or problems in the real world. If you are going to compete and win in this world, you better get your battle gear on. Getting to the next wrung on the ladder is a battle, not a group hug.
My wife and I often talk about when we left home for our first real jobs. We had each other, a car, a car loan, some clothes, and a lot of hope – nothing more or less than these things. No one promised us anything, much less a high-paying job, just an entry-level job and a chance to prove ourselves.
Sometimes life is a race, but for most of us, it is a slog where keeping your eye on long-term goals pays off more than get-rich schemes. You need to work harder and smarter than your peers to get ahead. If your job does not pay enough to save, even if just a little, consider getting a second job or a different job or adjusting your spending habits. Making informed financial decisions, such as smart spending and saving, can pave the way to financial stability and control.
The BIC Pen Lesson
It is difficult to think about thirty or forty-year goals when fresh out of school, but this is one key to building wealth. One lesson I remember from a college marketing class concerns BIC pens. The professor made a memorable point when he pulled out a BIC pen and made a line on a piece of paper. Then, he pulled out a Montblanc pen and made a parallel line. The lesson is that the purpose of a pen is to make a line on a piece of paper; everything else is marketing. Once made, you cannot tell the difference.
All costs beyond the BIC pen cost are psychological manipulations to convince you that the line made by a more expensive pen is superior to the BIC pen line. Millionaires own BIC pens, not Montblancs, unless someone gives it to them. Inwardly, they smile or chuckle, knowing they got someone else to spend their money and then give it away. Many will put the Montblanc pen in the drawer and keep writing with their trusty BIC.
The Joy of Compounding
One of my first assignments was to work with a man who understood the practical side of accounting. He taught me to appreciate the process and results that can come from understanding how money works. He mastered finding small amounts of money he aggregated into tangible amounts. One of his favorite sayings was:
“I love compound interest because it works twenty-four hours a day, 365 days a year. It works for me, and I don’t have to do anything once I put my money to work. Rain or shine, day and night, it keeps compounding.”
With interest rates as low as they have been in recent years, this would apply more to stock or bond market investments than a savings account, but the principle is the same: Save a little, put it to work, and watch it grow. No amount of money saved is too small; it all compounds.
My old boss was in good company; many shared his knowledge and wisdom.
“Compound interest is the eighth wonder of the world. He who understands it earns it…, and he who doesn’t… pays it.”
Albert Einstein
“My wealth has come from a combination of living in America, some lucky genes, and compound interest.”
Warren Buffet
“I think people don’t understand compound interest because typically no one ever explains it to them and the level of financial literacy in the U.S. is very low.”
James Surowiecki
Sources of Wealth
I want to look at just three sources of wealth overlooked by the current generation entering the workforce: coffee, smoking, and cars. Of all the wasteful habits I see, these three affect all socio-economic groups and are some of the easiest to correct. Changing just a few habits will let you accumulate as much as $1,000,000 from age twenty-five to age sixty-five. In the analyses, I used an interest rate of 5%, which is conservative. You can do better!
A Cup O’ Joe Please
We have become a nation of coffee drinkers partly because of Starbucks and the allure of designer coffee sold in experiential coffee houses. The Starbucks website lists thirty-two coffees in four sizes, which you can preorder or get in the store. And then there are shots, espresso, toppings, sweeteners, flavors, foams, drizzles, and whipped cream. Then there are the impulse items to buy in food, cups, ground coffees, and sandwiches. You get the message.
A twenty-five-year-old who changes their coffee habit intending to save just $5.00 a day on coffee and save that money will accumulate $233,164 by age sixty-five. You do not need to swear off your favorite coffee shop; just agree that wealth accumulation is more important than spending the extra money on frills and having the discipline to save it.
Maybe you work in an office where coffee is free. Make your coffee at home and refill it at work. Your wealth will accumulate even faster. If, for some strange reason, you are hung up on the Starbucks image, buy a Starbucks tumbler and refill it with your own coffee. Your less wealthy friends will never know the difference until you retire and leave them in the dust.
Drop the Cancer Stick
Remember when the Federal Government promised, as part of its massive class action lawsuit with tobacco companies, that all the additional taxes would go to education about the risks of smoking? Somewhere along the line, the taxes kept coming, and education disappeared. Now, new generations know nothing about those promises and only see (but not read) the warning label on each pack of cigarettes.
According to the World Population Review, the average cost of a pack of cigarettes is now $8.00. State taxes vary, but this is a good working number unless you live in New York, where a pack is $12.00.
According to the CDC, smoking habits still cut across all ages, ethnicities, genders, and income levels. Interestingly, you are more likely to smoke if the government is paying for your health insurance. I guess we can refer back to education by the government thing.
Assuming you are a one-pack-a-day person who gives up smoking at age twenty-five, you will save $373,062 by age sixty-five.
If you do not smoke, that is even better from a health perspective. But transfer the $8 per day to savings as a reward for being smart, and the math is the same.
A Good Ride
Many people who cannot afford a new vehicle, a “good ride,” buy one anyway. Cars and trucks are not investments; they quickly lose value and drain your wealth. The size of our great nation makes owning your transportation a necessity for most Americans. But that does not mean that buying a new vehicle is smart. Cars and trucks lose about 20% of their value when you drive them off the lot. Then, they depreciate (lose value) daily until the value plateaus years after the initial purchase. Theoretically, only an electric vehicle depreciates to zero because of the battery replacement cost. Gas powered vehicles are always worth something; if you maintain yours well, it will last a decade or more.
If you replace your car or truck every five years with a two-year-old one, you will save about $10,000 to $15,000 each time. Over forty years, you will trade seven times, saving $70,000 to $105,000. This will not show up directly in your bank account because it is cost avoidance, not money in your hand, but it is there. It shows up by having more money to spend or save after a payment, which is real. Keep doing this; eventually, you will pay cash for your cars and have no loan.
Save $15,000 every five years for your replacement car, and you will avoid $322,392 in costs.
Putting It All Together
Becoming a millionaire in America has always been possible for anyone with the financial discipline to make good decisions. Nothing here requires a highly-paid profession or a college degree. There is no real lifestyle sacrifice unless you derive your self-worth from Starbucks, smoking, designer items, or driving a new car.
There is a point in this process where things can get even better if you are careful. Eventually, you can swap your savings from a savings account to an investment account. When this swap occurs, history tells us that you can expect a slightly higher level of return, and these figures might be conservative. A 5% return is minimal, and long-term savings will be closer to 8% when reinvested, boosting your total savings to well over $1 million.
Today, you have some technological advantages that can also help. Many online banks and financial institutions allow automatic transfers, and you can easily set up a system to make a daily transfer from your checking account to a savings or brokerage account free of charge. Some banks now allow you to “round up” every transaction in your account to the next dollar, with the “change” going into a savings account. While this might seem like nothing, many small amounts transferred daily add up. The actions might seem trivial, but they are daily reminders of your commitment and progress.
You may live in your parents’ basement for now, which may be a little embarrassing. But it means you have parents who care, and you can use this time to springboard your savings way ahead of your peers. Never complain about free rent; save it and then get out on your own with a savings safety net.
A Final Word
One rude awakening for everyone coming out of school and entering the workforce is learning that it is really a “Dog-Eat-Dog” world. No one is helping you plan your career because they are busy planning their own. Part of their plan is to ensure they get the next promotion. They need to outwork and outperform others, including you. No one cares about your feelings, race, gender, degree, school, or problems. Sorry, but in the real world, there are no safe spaces, only a battlefield.
There is no substitute for hard work, producing results, and wise decisions. In America, everyone who wants to be a millionaire can become one who has an eye toward the future and financial discipline. In this article, we only looked at three small changes to habits; there are many more.
Resources
Current Cigarette Smoking Among Adults in the United States, Centers for Disease Control and Prevention, cdc.gov, Last accessed May 10, 2024.
The Millionaire Next Door: The Surprising Secrets of America’s Rich, By Cotter Smith and Thomas J. Stanley, Ph.D., 23rd Printing, January 1, 1998.
Calculations
Cup O’ Joe
$5 x (((1+(.05/365) ^ (14600)-1) / (.05/365))) = $233,163.61
Smoking
$8 x (((1+(.05/365) ^ (14600)-1) / (.05/365))) = $373,061.77
Vehicle Cost Avoidance
$15,000 x ((1+(.05/365) ^ (12775)-1)) = $86,308.70
$15,000 x ((1+(.05/365) ^ (10950)-1)) = $67,218.43
$15,000 x ((1+(.05/365) ^ (9125)-1)) = $52,350.66
$15,000 x ((1+(.05/365) ^ (7300-1)) = $40,771.44
$15,000 x ((1+(.05/365) ^ (5475-1)) = $31,753.37
$15,000 x ((1+(.05/365) ^ (3650-1)) = $24,729.97
$15,000 x ((1+(.05/365) ^ (1825-1)) = $19,260.05
Total Avoidance = $322,392.62
