Want to Crush Financial Independence? Here are Two Financial Concepts Young People Should Know, No Matter Their Income.
As young-ins, you have one of the most powerful forces in finance at your disposal.
No, I’m not talking about your future earning potential, charm, good looks, or impressive head of hair—I’m talking about your time.
Listen up young bucks:
Your money is more valuable now than it’ll ever be.
That’s because right now you’ve got way more time to let it grow and compound.
Concept #1: The Power of Compounding
What is compounding?
Compounding is earning interest on your interest.
And over long enough periods, the effects of compounding can be staggering. To help illustrate, let’s explore one of the best chapters of one of the greatest personal finance books of all time: The Psychology of Money: Timeless Lessons on Wealth, Greed, and Happiness by Morgan Housel.
Chapter 4: Confounding Compounding.
To understand how powerful compounding can be, Housel directs us to one of the most legendary investors of all time: Warren Buffett.
Housel writes:
“More than 2,000 books are dedicated to how Warren Buffett built his fortune. Many of them are wonderful. But few pay attention to the simplest fact: Buffett’s fortune isn’t due to just being a good investor, but being a good investor since he was literally a child.
Housel continues:
“ As I write this Warren Buffett’s net worth is $84.5 billion. Of that, $84.2 billion was accumulated after his 50th birthday. $81.5 billion came after he qualified for Social Security, in his mid-60's.
He goes on:
“Warren Buffet is a phenomenal investor. But you miss a key point if you attach all of his success to investing acumen. The real key to his success is that he’s been a phenomenal investor for three quarters of a century.”
Let’s pause right there.
99.64% of Warren Buffetts wealth came after his 50th birthday. Like Housel says: “Our minds aren’t built to handle such absurdities.”
There’s a couple takeaways to consider here:
Go read this book. If you haven’t read the Psychology of Money yet then I highly recommend you pick up a copy and study it. It is one of, if not the best, personal finance books I’ve ever read.
This concept is not intuitive. Our minds aren’t built to handle the absurd wizardry of compounding. That’s okay, just do your best.
If you’re a visual learner then this should help.
There’s how we think investing works:
Then there’s what actually happens:
But why? Let me explain:
When you invest money, you receive a return in exchange. Returns vary by investment, but consider that the S&P 500 has averaged a yearly return of 10.49% over the last 50 years.
Here’s how it works over 5 years.
Say you start with $100 in the S&P 500.
Year 1: $100 (+$10.49 return)
Year 2: $110.49 (+$11.59 return)
Year 3: $122.08 (+$12.80 return)
Year 4: 134.88 (+$14.15 return)
Year 5: $149.03 (+15.63 return)
Notice how your returns are growing?
You haven’t changed your investment plan or invested anything additional, but each year, the previous return is added to the existing balance, and your return grows. What starts out as +$10.49 per year turns into +15.63 per year in just 5 years. Add a few decades and a couple zeros and things really start to get exciting. That’s the power of compounding.
Concept #2: Coasting to financial independence.
So here’s the gist: because you’re young and have time on your side, you can knock out the bulk of your retirement needs early, allowing you to coast to financial independence while your money works for you.
What is Coast FI?
Coast FI or “coasting to financial independence” is a variation of the financial independence retire early (FIRE) movement.
Coasting is all about reaching a point where savings becomes optional rather than attempting to reach a point where work becomes optional. Then, “coasters” can work flexibly on their own terms to cover their living expenses while their assets grow and compound in the background.
It’s a more balanced and sustainable approach to financial independence, with less emphasis on “retire early” and more emphasis on “freedom and flexibility.”
Here’s how to use this to your advantage.
If you can get a nest egg built early, you can let it ride for decades. But how much do you need and how early do you need it? Let’s explore:
By Age 25
Invest: $67k
Achieve: $1 million at age 65
Consider this: if you could get $67k invested by the time you’re 25 years old, you would have over a million dollars* (adjusted for inflation) by the time you’re 65 years old.
In other words, you could literally knock out most, if not all, of your retirement needs by investing $67k by age 25 and then letting it compound in the background for the next 4 decades. All while you work flexibly to cover living expenses.
*(Assuming a 10% annual rate of return and 3% inflation over 40 years.)
By age 30
Invest: $94k
Achieve: $1 million at age 65
Assuming you want the same $1 million adjusted for inflation by age 65, you’d need to invest roughly $94k by age 30. Boom. Then you’re free to let your money do the heavy lifting while you work on designing a life you love.
By age 40
Invest: $184k
Achieve: $1 million at age 65
Now we start to see the effects of compounding. If you wait just ten years from age 30 to 40 then you need to invest almost twice as much to achieve the same $1 million at age 65.
By understanding these two concepts, you can unlock incredible time freedom and wealth, no matter your income. And for young people, the power of time is incredible, allowing small investments to grow into significant wealth over the years.
Key Takeaways:
Your money is the most valuable it’ll ever be right now.
The earlier you start, the less you need to save.
Compound growth is exponential—the longer it goes, the faster it grows.
You could knock out the bulk of your retirement needs by age 30.
Then, by securing your retirement needs early on, you are free to work seasonally or part-time to cover your living expenses.
Want to learn more about coasting to financial independence?
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