Dave
Joined: 22 Dec 2005
Posts: 1644
Location: Washington, DC
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Subject: Why Your Second Million Is So Easy
 Posted: Tue Aug 07, 2007 12:09 pm |
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Why Your Second Million Is So Easy
You've probably heard “your first million is the toughest,” but didn't initially appreciate the wisdom. Recently Motley Fool had an article on just that (concluding that once you have a million bucks, compounding makes the second million easy). And although compounding is the primary reason your first million is tough and your second million is easy; there are other factors that make amassing your first million more difficult than your second.
Compounding: Doubling Your Money to the Sky
In an article on compounding growth, PV Subramanyam wrote:
| Quote: | If compound interest is so simple that it is taught in high school, how come it took a brilliant man and arguably the greatest scientist in the world [Einstein] to call it the 8th wonder of the world?
Was it to remind us that we forgot about a magic theory? Really, understanding compound interest is very, very difficult. The human mind does not comprehend such growth so easily. We in our physical selves have a simpler type of growth. So we do not comprehend compounding of growth. |
Compounding is just another name for exponential growth, where the growth rate is proportional to size: the bigger you get, the faster you grow. I use a technique I call “doubling” to better understand compound interest. Your money will double every number of years at a particular interest rate. You can easily find the number of years it will take to double your money by using the “rule of 72.” Just divide your interest rate into 72 to find the number of years it will take to double your money. By the way, if your money is compounding monthly rather than annually, you can use “the rule of 69.”
20 Years to Make the First Million, 5 Years to Make the Second Million
Wealth is a game of doubling and at 15% return, it takes 5 years to double your money.
That means if you start with $62,500, you'll spend 20 years reaching your first million and 5 years reaching your second.
The Other Reason Your Second Million Is So Easy
The good news is making money gets easier. You probably think that amassing wealth is as simple as stopping spending and starting to invest all your saved money-- and you'd be right. But just try that for a month and you find out how difficult it is! It may be simple, but clearly, it's not easy. And although it's difficult at first, building wealth by cutting your expenses, saving and investing is a learned skill, and like any learned skill, you get better with practice. And as you practice, you get better at making the choices that affect your ability to amass wealth. And those decisions either help you or hinder you on the way to financial freedom.
Let me give you a personal example: we have no TV reception in our home. No antenna, no cable, no satellite dish, no nothing. Although we made the decision primarily for the kids, I know that my finances benefit as well. How? It has been shown that people watching the average amount of TV (28 hours a week) are influenced to spend $5,600 more a year by television commercials. Over 20 years, the opportunity cost of that $5,600 a year is $350,000 (invested at 10%). And think of it this way: how much are those 1,456 hours spent watching TV every year worth to you? To me, they're worth $20/hour, so I'd be blowing another $29,120 a year in my time watching the average amount of TV. I spend the time I would have been watching TV making money and cutting expenses. For instance, I'll be taking care of the house and the yard, maintaining the car, repairing appliances, playing with the kids, sailing or maintaining our boat, selling items I've found or don't need, and writing a book. How much is the time you spend watching TV worth to you? I think you'll find the less time you spend watching TV, the more valuable that time will become.
PersonalBusiness: Stop Playing the Patsy and Start Making Money
We've created the PersonalBusiness to help you develop your wealth making skills. It's a way to stop being a Madison Avenue patsy and start thinking about your personal finances from a profit and loss perspective. Madison Avenue's game is to talk you into transferring your money to their advertisers, and they are very good at their game. Every year they talk folks into borrowing money for depreciating consumer goods, buying more than they need, and generally throwing their money away. If you want to start making financially savvy decisions, all you need to do is evaluate them from the prospective of a business owner. At the most basic level, all you have ask yourself is “is this the most profitable use of my time and money?” It's not as difficult as it seems, all it takes to get good is time and practice.
Do You Expect to Become a Tennis Star by Next Week?
You'd never buy a book entitled “Become a Tennis Star by Next Week,” would you? You understand that becoming a tennis star takes practice-- a lot of practice. But there seems to be no limit to the number of people that are willing to buy books to “Become a Millionaire by Next Week.” The irony is, becoming a tennis star and becoming a star at amassing wealth take much of the same thing: practice. The common misconception is that wealthy people “got rich quick.” They didn't. They either spent their time building businesses that generated income and had some sale value, or they saved and invested.
Building Wealth Takes Time and Practice, Not Luck
I have many self-made millionaire friends, and they all have one thing in common: they've worked long and hard building their wealth. One lawyer I know worked long and hard building his business (15 years) before selling it for $1.5 million and then focusing on his law practice. Building a business almost always take a long time and a lot of hard work, and the right opportunity. And more often than not, the first business turns out to be the wrong opportunity. That's why than half of new businesses fail in the first few years.
How You Can Get Rich Working for the Man
A common misconception about wealth is “you never get rich working for someone else.” As it turns out, working for someone else, and focusing on cutting your expenses and investing your savings is the guaranteed way to wealth. Let's take the example of my friend that sold his business for $1,500,000 after 15 years. What if he had been saving and investing his money over those 15 years-- how much would it take? It turns out it only takes $27,000 a year. If you invested $27,000 a year at 15% for 15 years, you'd have that same $1.5 million at the end. You might think $27,000 is a lot to save every year, but it's not. That $27,000 is what you keep, not what you spend. It is your money. A big difference between starting a business and saving is this: if you start business, you have no idea how much you'll be able to sell it for in 15 years, if anything. Saving and investing are the guaranteed way to wealth.
Becoming a Wealth Building Star
Getting good at building wealth is just like getting good at anything else: it takes time and practice. Sure, you might have a natural talent for building wealth-- some people do. But chances are, if you're reading this, you weren't born with the natural ability for generating wealth. Don't worry, neither was I, and we don't need to be! If you run your personal finances like a business, meeting your financial goals, your wealth building skills will improve over time. Read our article on how to “start thinking like a millionaire” on developing your skills to make money, or “how to save $20,000 on your next car.” Once you're focused on running your PersonalBusiness, your money making and expense cutting skills will be getting better and better. We hope you'll find HowWealthWorks.com one of the places to use on your journey to financial freedom!
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Dave
Please feel free to agree with or critique the article excerpts and our comments. Alan Greenspan: Gold and Economic Freedom |
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