Being able to amass $750,000 is by no means an easy feat. It requires not only early planning but also tight spending control and making some investments with a high level of conviction. Longtime readers of my blog A Path to Forever Financial Freedom would know that it has been quite a bit of a stretch for me to try achieving Financial Independence, Retire Early (F.I.R.E.) during this interim period of working life before I turn 35 (in 2020). To accomplish this goal, I've had to adapt and adjust many times since I started on this path about eight to nine years ago. In my view, there have been three critical levers that I have focused on to achieve my goal.
First Lever: Income Growth through Career Advancement
Income factor is one of the most important aspects of the three levers: I wanted to grow my human capital as fast as I could. Most of us grow our capital base by being an employee, working a day job from 9 to 6. In this sense, the first salary base that we get from our first employment plays a big part in the future wealth compounding. If we start from a low base, it takes even more time to play catch up at a later stage. While luck often plays a big part in determining one's first job, but I didn't want to be dependent on what I could not control.
For example, there is usually an annual increment exercise for most multi-national companies, so employees should gradually see their income grow higher over time. However, the growth part is a critical factor like most valuation methodology in investing so we need to play it smart. In order to think about this smartly, I wanted to distinguish the difference between progression and promotion.
Progression means you probably did okay and the company survives another year so everyone in the company gets about three to four per cent increment the following year.
Promotion, on the other hand, means you get a new responsibility and are promoted to the next level, so your increment should be higher, generally about two times higher at six to 10 per cent. of course, promotion doesn't come often and depends on many factors; however, if you can consistently do it, you'll win the rat race within the company.
In fact, jumping to another company immediately after your promotion will probably give you the best ROI, as illustrated below. I've seen a lot of people who do this and many employers agree this pose a big risk to the company in terms of losing talents.
In my 10 to 11 years of working experience so far, my income has grown at a CAGR of about 14 per cent a year, which I think has played a tremendous boost to my ability to contribute more capital into my investment portfolio.
2nd Lever: Savings Rate
Having a high income without establishing a tight spending control is equivalent to having a good Ferrari car without the proper tyre. The higher the savings rate, the more likely you are to have excess funds at the end of the day.
While it may seem pretty obvious that we need to spend less than what we earn, the reality is that doing so is not easy to digest until we are accustomed to seeing things differently. For example, someone who already started with a low savings rate when he is single because they love spending on gadgets or other needs will have a difficult time adjusting his spending pattern once the tough gets tougher.
The reality is that your savings rate would likely decline over time as you tend to start your own family, have children, buy tonnes of milk and diapers, renovate your home and furniture appliances and many more. In my case, I managed to achieve a very high savings rate of almost 80 per cent when I was single, but it slowly dropped to 40 per cent after getting married and having kids.
The ability to continuously save an excess amount of capital every month means I am able to put the money to use to invest and grow my portfolio. This is especially important to do so when you are young and single since your savings rates will be higher and because starting early is crucial when it comes to compounding returns, which I explain next.
Third Lever: Compounding Returns
The last lever is arguably the most difficult and is the last piece of the wild card. Achieving the first and second lever is good enough, but being able to benefit from compounding returns can provide a huge kick to your portfolio. Compounding returns allow one to grow his wealth simply by relying on time.
For example, even if everyone could earn 10 per cent returns every year, someone who started investing 10 years earlier would be worth more than double what another person who started later. When your money can compound over a long period of time, the growth can become exponential. This is why it's so important to start investing early, either through bank deposits, equities, bonds, property or any asset class that generates positive returns.
In order to do this well, I had to spend the first few years building up my level of competencies. The skills and experience that I accumulated over the years played a significant part in compounding my returns.
Many people expect the outcome to be immediate when they start investing, which is a big mistake. A lot of times, much of the good returns instead come from refining your investment and research process over the years, and I had to dedicate a lot of time and effort to do so. In my case, I managed to achieve a return in the stock market of around 19 per cent per annum in the last 9 years of investing through fundamental investing strategy, though there are also many other strategies out there.
Everyone knows the formula to building wealth is:
|Crazy Income + Crazy savings rate + Crazy Compounding rate = Crazy F.I.R.E|
However, it took a lot of refining and adaptation over the years before I was able to fine-tune my lifestyle. And I am still always in the process of learning new things in order to make it better. The hardest part is in the execution and maintaining the determination of wanting this to succeed badly.
This article was first published in ValueChampion.