How To Upgrade Your Savings And Become An Investor

4 min read

I have been interested in Money my whole life. Trying to hoard it and trying to grow it. It started when my Aunt asked, “How would you like to be a millionaire?” Then proceeded to give me a cassette tape course on the power of compound interest. At the time I didn’t understand how to earn 12% interest per year. What I did understand was that you can’t invest, if you don’t have the money. 

How I went from budgeting to investing

There are two steps to becoming an investor: 

Step 1: Create a Financial Buffer 

Step 2: Invest your financial buffer for as long as you possibly can. 

The initial step on the path to investing is spending less than you earn. The financial buffer, created in step 1, is the safety net that makes it happen.  Once you prove to yourself that you can live on less than you earn. You can start making your money work for you.

The career or trade you choose will have a strong influence on your ability to create a financial buffer. I have represented the relationship between income and the financial buffer with an equation.

Step 1: Building a Buffer

The three adjustable levers that determine your financial buffer are income, consumption, and debt. Many financial pundits discuss these three items independently, but few people talk about the relationship between them.

You may ask,

“Jesse. Isn’t the appropriate level of debt Zero? Shouldn’t I try to keep my consumption as low as I possibly can?”

The answer is, “It depends.” The limiting factor in achieving your financial buffer will be your happiness. Are you able to stick with your plan for 20-30 years? If you are satisfied with the lowest expenses and no debt, work that plan.  If you want to have the newest designer clothes and a smaller house, work that plan. I’m presenting options as a dynamic framework. You can do anything. You just can’t do everything at once. Figure out the buffer you need, and cut things that don’t add value. 

I recommend starting with the end in mind. My family commits to a monthly savings goal to pay ourselves first. Then we prioritize our spending with the net income. This is a lot easier than nitpicking every expenditure for the month.

Step 2 is the fun part. At least it is for me. This is the part where you start separating your income from your output. You start earning passive income while you sleep. Of course, I have a general equation for this relationship, as well. 

Step 2: Passive Income While You Sleep

The passive income equation is a generalized form of the compound interest equation. This equation highlights three variables responsible for generating passive income. Those variables are your financial buffer, the interest rate earned on your investment, and the duration of your investment. 

Out of three variables, you can only control two. The amount of your financial buffer and the duration of your investment. This is okay though. You don’t need to control everything to get great results. Two variables, applied consistently, can lead to great returns within the passive income equation.

Using the Passive Income Equation

The equation is an exponential function. The key principle of exponential functions is that after an initial duration, your interest earned will exceed your contributions. This is the power of compounding. See the charts below for examples of portfolio growth at 6% APR and 12% APR:

Time has a way of smoothing out market volatility. Interest rates vary, but staying invested for the long term you will give your investments more opportunity to grow. Let’s consider the case of a 12% annual interest rate.

With a 12% annual interest rate, the passive growth takes over contributions in 6 years. This is less than half the time it took with an annual interest rate of 6%. A higher return on investment is a great thing. However, double-digit returns are not promised.

While it is difficult to permanently lock-in interest rates on investments. You can influence the interest rate by choosing investments that have historically performed within your risk profile. However, don’t mistake influence for guarantee.

Does this sound familiar?

“Past performance is no guarantee of future results”

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Conclusion

The best you can do is control what you can control. Create your financial buffer. Choose an investment vehicle. Stay invested for as long as possible. 

Don’t take my word for it. Ask the world’s 3rd richest man. 

Hey Warren! How long should I stay invested?

“If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes.”

– Warren Buffett