I have a theory. Even if most people appreciated basic math just a little more – and the power it can have on their financial lives – they still would not fully use it to their advantage.
Many of us in this country – in this state, in this county – have the chance to create a personal fortune during our lifetimes. But many of us won’t, partly because we do not have a full appreciation for simple math and partly because understanding math is only half of the equation. And the other half of the equation is the challenging part.
Let me explain.
There is a dull word in finance that has tremendous ability to change your life. The word is ‘compounding.’ As words go, compounding is pretty boring. I think we would all be better off if instead of ‘compounding,’ we called it ‘super juice.’ That’s what it really is.
If you want to be wealthy, you have to understand super juice.
Here’s how it works. When you place money in a bank or in an investment, it hopefully generates a return. If you do not spend that return, it can remain in the account to generate additional returns in the future. At that point, not only do you have your initial investment making money for you, you also have your returns making money for you. That’s super juice. That’s compounding.
Most of us grasp the concept. What gets tricky is thinking about the concept over long periods of time.
The problem with super juice is that it works on a delay. For years at a time, even decades, it seems like super juice doesn’t work at all. It’s like an explosion with a long, slow-burning fuse. We light the fuse and nothing happens. We wait. We wait. We wait. Then, BOOM!
The concept is simple. Seeing it play out in real life is tougher to comprehend. How about a quick example?
Warren Buffett is the world’s third richest person, according to Forbes magazine. He made his fortune of $88.3 billion through years and years of savvy investing. Buffett used super juice. But even he had to play by the super juice rules. Even he faced the delay in the explosion. Get this: $88 billion of his $88.3 billion in net worth was made after he turned 50 years old.
Wait, wait, wait, BOOM!
Here’s the thing. Even if you understand how super juice works, it’s not enough. That’s the easy part. The second half of the equation is what trips up too many people.
Super juice cannot work miracles on its own. Just as a bomb requires a reactive substance to produce the explosion, super juice cannot work without help. When it comes to creating a fortune, your savings are the reactive substance. The more you save, the bigger the bang when super juice works its magic.
Fortunately, we get to decide on how much we save. That’s a choice we make. That’s the second half of the equation, and it’s one of the largest factors in determining how big an investor’s fortune will ultimately be. It takes diligence. It takes sacrifice, in many cases. But the results can be astounding.
We have likely all heard we should save early in our lives. The reason is the math behind super juice, behind compounding. But it’s not enough to appreciate basic math. To make super juice work wonders, we must also have the discipline to keep adding fuel, to keep adding savings, even during the long, boring period of delay before the explosion.
How long is your fuse? How much fuel are you adding? How big of an explosion do you want?
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