A lot of people are big on being frugal and saving money, but can being frugal really make you a millionaire? Will you be set for life if you avoid your $5 starbucks, spend $3 less on groceries per day, or get $9 off on diapers once a month? Where do these decisions actually put you?
I am one for being frugal, but it’s my opinion that investing is often an underplayed element for becoming financially independent. Furthermore, when you truly look at the long-term picture, it is absolutely required that you consider inflation (many do not). What you have in 30 years will be worth 44.5% as much in actual spending power (assuming 2.75% yearly inflation).
For example, let’s say you save $10 a day ($300 a month) and you earning a 4% return on this money (deposited at the end of the month). After 30 years (3 decades) you would have an after-tax amount of about $181,611. If you discount this by an inflation of 2.75% over those 30 years, it’s $82,693 inflation adjusted. Now as that might sound like a good amount of money, let’s not forget that you added $108,000 of non-inflation adjusted contributions over those 30 years. Now in theory you could increase your contributions by inflation (second year would be $308.25 a month and so on) , but the point remains, you are getting no where. If you were to make the inflation adjusted contributions in fact, you would have an after-tax amount of $258,832, an inflated adjusted amount of $117,854.
These numbers might seem almost impossible, but don’t forget that returns are taxed making your effective rate of return 3.4% – 3.0% (depending on tax treatment), and after inflation, it heads down to .65% – .25%.
Investment is the true key, not being Frugal
Investment is the only non-luck way for an average blue collar Joe to end up financially secure. Take the same $300 a month (non-increasing) and try 15% a year return, the amount becomes an after-tax $873,183. This amount is an after-inflation adjusted $397,587. An amount nearly four times as big. In fact you only need to save $62 a month @ 15% return to get the same effect of $300 a month @ 4% return.
Four Percent Return is a very common practice
You might be reading this article saying, who in the world goes for a four percent return? Sadly it is extremely common, and it comes in the form of paying down your mortgage. Although it does offer a sense of accomplishment to have no debt/no mortgage, it is arguably one of the most painful long-term financial decisions you can make. Opportunity cost is never considered as people blinding throw money at their mortgage, causing them to miss out on piles of money that they would have received if they had invested properly. To add insult to injury, if you have a 4% loan that is currently itemizing, whatever you pay against the mortgage is effectively giving you a return of only 3%! You are literally buying your way out of a tax benefit.
The bottom line is that if you are focusing on frugal and not on investing, you are missing out on a lot of potential net worth. You might argue that 15% yearly return is too high, but I would argue that it is very obtainable with minimal risk. Don’t let your money fall into the mortgage trap or even worse, the CD or savings trap. Make your money work for you, and obtain financial independence.
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