Financial Freedom: Behold the Power of Compounding Interest

Financial Freedom: Behold the Power of Compounding Interest

What would you do if money was not an issue?  How would you spend your time if you were independently wealthy and your livelihood was not a recurring concern?  My guess is that you would not waste your life on triviality and self-indulgent leisure.  Most likely, you would fulfill your God given purpose and your divinely ordained potential by chasing after the goals that He has given you the passion to pursue.

Unfortunately, the reality is that most of us are not independently wealthy.  Money is an issue.  Our livelihoods are a recurring concern.  In life, we are all torn between what we have to do and what we want to do and, in order to survive, we are forced to trade our time for money engaging in activities and work we would rather not do in the hopes that there will come a point in the future where we might find ourselves in the position where we no longer have to make this bartered exchange – where we can finally engage in life pursuits that fulfill us and give us the sense of satisfaction that only comes in doing the things we were made to do.  But, until then, fulfilling God given potential and pursuing God given purpose must be relegated to the hours we can spare beyond our nine to five. 

Is there a way to accelerate the timeline – to be able to retire from the grind before we are too frail and too weary to live the life we are meant to?  There is.  If we can save and invest wisely so that our money takes our place in the daily grind, we can finally be in a position where we are no longer forced to trade our time for money. 

So, where do we start?  Financial freedom begins with the acquisition of the proper knowledge base and the initiative to take back control of our financial destiny. 

Knowledge is Power

There is a great deal of information available for public consumption on the subject of money.  And yet, it remains a subject matter that holds the unique and somewhat ironic distinction of being so important to every individual, but at the same time, one that is so seldom pursued as an intellectual discipline despite the fact that it holds out for its pursuer advantages that are both cerebral and eminently practical.   Ask the average person about certain aspects of their financial portfolio and the rationale for some of their investment decisions and seldom do they ever give an informed answer to such an important question. 

Why is that?  The sheer volume of information available to the average person is overwhelming and ever expanding.  The universe of investment products is constantly in flux and so the average person feels demoralized by the copious amounts of data and they have somehow come to the conclusion that sifting through all of that information is either impossible or not worth trying.  The average person then hands over control of their livelihood and their financial well-being to someone who, with few exceptions, has fixed their own self-interest and financial well-being at the north point of their moral compass.  The results of such a course of action have proved disastrous for many.

A few years ago, I was in the very position now occupied by so many – a no man’s land where my financial destiny was being controlled by individuals whose priorities and primary focus remained divided amongst so many competing interests.  I decided to take control and embarked upon a course of disciplined study to navigate what was once an arcane and largely formless field of study.  I was able to filter the information and distill the data into what I believe to be its purest and most edifying form.  My intention is to share what I have learned over the next several posts. 

But, perhaps the most important lesson I learned was that financial freedom is attainable, it can be purchased.  That realization radically shifted my perspective on money and fundamentally altered all of my financial priorities.  It turns out that the road to financial freedom begins in earnest with a paradigm shift. 

Financial Freedom Can Be Purchased

It has been said that people generally fall under one of two categories: (1) those with jobs and (2) those with careers.  Those with careers welcome the dawning of every workday, and Monday mornings for them have a significantly different feel.  Individuals fortunate enough to find themselves in this position are few and far between.  The vast majority of the working population fall under the former category.  I was one of them, and for me a paradigm shift was most urgently needed. 

Henry David Thoreau once made the observation that “most men lead lives of quiet desperation.”  For most, their jobs have become an albatross – dead weight suppressing the ambitions and the passions of those shackled to an occupation that pays the bills, but does little else.  For those who fall under this category, a simple truth is tendered – financial freedom is attainable.  Whether or not a person accepts that truth will determine that individual’s life paradigm and the future direction of their financial life. 

Now, many have discarded this truth as either a myth or a dream deferred into the very distant and imperceptible future.  Still others trade that freedom for the ostentation of perceived wealth, shackling themselves to their occupations with gold-plated chains and digging themselves in deeper and deeper with every passing purchase.  As a result, many live their day-to-day lives devoid of any hope of freedom, resigning themselves to their lot in life.  Their job becomes a cancer – a chronic and inoperable condition the pain of which can be momentarily dulled with the finer distractions of life (i.e. vacations, new cars, new homes, expensive hobbies, perceived wealth rather than actual wealth).  These individuals look forward to weekends and fleeting reprieves to momentarily assuage the anguish of an occupation they hate only to get up every Monday morning to reassume the burden.  In a very real sense they live a half-life.

Then there are those who internalize the truth that financial freedom is attainable and that hope initiates fundamental and wholesale changes to the way they live their lives.  These individuals fix their eyes upon that hope and drive themselves towards that horizon by opting to endure present discomfort and eschew the baubles of perceived wealth for the sake of a future characterized by actual wealth – total and complete freedom.   For these individuals their job is likewise a cancer.  The only difference being they’ve elected surgery.  They do not want to temporarily and periodically medicate the pain for the next forty years, rather they’ve elected to take in the full intensity of that pain now to give themselves the opportunity to purchase a life without limits.   They have chosen the better things and because they have their sights set on a future absent boundaries, though they may deprive themselves of momentary pleasures now, in a very real sense they live a fuller life than those who opt for the morphine. 

I had to make a choice – the baubles and creature comforts of perceived wealth or the freedom of actual wealth.  I chose the latter because I realized that my money and my possessions will either become my slave or my taskmaster and the decision was entirely mine.  Instead of working for my money, I chose to have my money work for me. 

And whether or not a person agrees with the premise, they cannot argue with the simple truth that for the vast majority of people freedom is the end goal.  Most people call it retirement.  And how much would a person give to retire one day sooner?  How about a year?  How about two years?  How about ten years?  Freedom can be purchased.  What a person does with their money now can either hasten or delay that purchase. 

Is it easy to attain financial freedom?  No.  It entails sacrifice and disciplined effort.  And in fact, sadly the sacrifices prove to be too much for too many.  But, the rewards awaiting those who endure far surpass the transitory pain of the deprivation in the here and now.  And those who fix their eyes on that goal, rather than their present discomfort will never regret that decision. 

Behold The Power of Compounding Interest

How much money do I have to start saving and investing in order to attain financial freedom?  Not a whole lot it turns out. 

Savings of $5 a day ($150/month or $1,800/year) 

7% annualized returns

10 years - $26,610

20 years - $78,957

30 years - $181,931

10% annualized returns

10 years - $31,556

20 years - $113,404

30 years - $325,698

Savings of $10 a day ($300/month or $3,600/year) 

7% annualized returns

10 years - $53,220

20 years - $157,914

30 years - $363,862

10% annualized returns

10 years - $63,112

20 years - $226,809

30 years - $651,396

Savings of $20 a day ($600/month or $7,200/year) 

7% annualized returns

10 years - $106,441

20 years - $315,829

30 years - $727,725

10% annualized returns

10 years - $126,224

20 years - $453,618

30 years - $1,302,792

Savings of $40 a day ($1,200/month or $14,400/year) 

7% annualized returns

10 years – $212,883

20 years - $631,658

30 years - $1,455,451

10% annualized returns

10 years – $252,448

20 years - $907,235

30 years - $2,605,585 

The US stock market generally returns about 10% in annualized returns over the long term.  Depending on how a person decides to allocate their assets, 10% annualized returns are achievable.  Even conservatively estimating at 7% annualized returns, the savings and the wealth generation through the power of compounding interest is a magnificent thing to behold. 

Warren Buffett once said, “Life is like a snowball.  The important thing is finding wet snow and a really long hill.”  Warren Buffett understood the power of compounding interest.  He saw the potential of a dollar better than most and viewed money saved and invested today, regardless of how miniscule the amount may appear at present, as equivalent to the fortune of tomorrow and every purchase was filtered through that lens.   

For those who say they cannot save this much money a day, a week, a month, or a year my response: You probably haven’t looked hard enough. 

Do you buy your coffee at Starbucks rather than making a cup at home?     

Do you shop at Whole Foods rather than Trader Joe’s?  

How fancy is your bottled water?  Should you be paying that much for water?

Do you buy your lunch every day rather than making it at home?

Do you go to happy hours regularly?

How often do you go out to eat?

What kind of car do you drive?  Do you need a luxury conveyance?

What adorns the walls and tables inside your home? 

How often do you shop for clothing and where do you go?

How regularly do you splurge on expensive vacations?

How many pairs of shoes do you own? 

The Rule of 72

The Rule of 72 gives a rough estimate of how many years it will take to double a person’s money given a specific return.  Divide 72 by the estimated return expressed as a percentage and you get the approximate number of years it will take for the initial investment to double. 

When I first started working over 15 years ago, I had a colleague who purchased a BMW X5 (current retail price approximately $70,000) instead of something comparable and far more financially responsible like a Honda Pilot (current retail price approximately $40,000). 

Let’s apply the Rule of 72.  Had my colleague purchased the Honda Pilot and invested the savings ($30,000) in a low-cost S&P 500 stock market index fund returning roughly 10% over the long term, he would have doubled his initial investment roughly every 7 years (72/10%).  Right now, he would have over $120,000 sitting in his investment portfolio, rather than the loss on a BMW X5 he likely sold or traded in a few years after he purchased it. 

Let’s take this a step further.  Suppose he purchased a used Honda Pilot (current retail price approximately $20,000).  Right now, he would have well over $200,000 sitting in his investment portfolio and he would be that much closer to financial freedom.  Were the few years of driving that BMW X5 worth $120,000 or $200,000? 

When purchasing patterns are evaluated in light of the power of compounding interest it becomes infinitely clear that after 20 years of disciplined saving and investing, every individual committed to financial freedom could be free – or, at the very least, within shouting distance.  And even if a person cannot wait 20 years – they cannot stomach the thought of working at their current occupation for another day let alone another 15 years – the simple truth of the matter is that a person living well below their means and amassing wealth has options and those living paycheck to paycheck have none.