We've probably all heard the story of compound growth. Get a penny a day and double the amount you get each day for 30 days and on the 30th day you are receiving 5.37million. Of course you'd prefer to be on the receiving end of that deal. This is the power of compound growth. But compounding costs aren't usually illustrated. What if instead of receiving a penny that amount was taxed or there were fees or other costs that amounted to 1/3rd in costs? You then receive 2/3rds of a cent the first period, and then before you can receive double the amount (1 and 1/3rd cent) the next time you again have 33.33% costs so you keep 66.67% (8/9ths of a cent), and the process repeats?
Rather than 5.37 million, you receive just $28. In my opinion this illustrates the destructive force the taxes have on economic growth with all other things being equal the nation with no taxes will grow at a much faster rate and be able to tax AFTER the fact at a very modest rate and still collect a lot more. To be fair, all things would not be equal since governments can reinvest in valuable projects and pay salaries to teachers, police, firemen, etc and they can in turn reinvest or grow or start a business or spend on another person's business. With that being said, I feel that this underestimates the impact of a global economy since people will migrate to the properous, growing nations with a consistent, low, tax rate, and even a growing country on paper can see much of the wealth move out of the country to the more competitive tax rate.
But this is not about politics so I digress. The point of this is there is a huge advantage to avoiding fees and hidden fees, avoiding costs and taxes, and allowing pre-taxable growth to compound if possible.
Finally there is compound savings. If you learned to be a spectacular trader and can earn 80% a year what is the value of savings a dollar per week for 10 years? On paper, you have only saved 52*10 or $520. But after 10 years of compounding the prior total with a new total of 52 each year you end up with $23,143 more in your pocket. Go back to spending $1 a week after that for the next 10 years but keep your money compounding and that $520 (now $23143) becomes more than $8.2 million in 10 more years.
The long term effect of small changes one piece at a time is amazing not just in financial terms. If you need to lose weight try cutting back 1% of the calories each day for a month and then decrease them another 1%. Or try running 1% more on average per day each week. There are of course limits that eventually need to be implemented so you don't continue cutting calories until you are underweight and starving or deprived of certain types of calories until your body begins aggressively storing fat as fuel. But if you just trim back some of the excesses of life and also convert the energy into more productive energy (whether that be saving time and money and reinvesting it into a business, or increasing your energy towards life and channeling that into work or studies or your passion, or acquiring knowledge or a skill set), it can make a big difference given enough time.
Want to kick a habit like smoking? Think of the costs in terms of what if you were able to go with 1 less cigarette a day for 10 years? Then after a month later think of going 1 less yet again and figure out how much it adds up. Then 1 more again and so on. Ultimately it is the little steps at a time with the long term in mind that makes a difference. Constant and never ending improvement.
I am not one to obsess over frugality, but when investing it is important to avoid hidden costs, try to deposit a little more, make sure you can reduce some of the losses and keep money compounding and learn how to gain just that little extra edge that will compound over time that does add up especially if you are trying to get yourself into a more favorable situation.
There are plenty of tricks to squeeze out a few bucks that can add up overtime if those bucks are reinvested well. If you are one that buys into frugality and you are looking to come up with all the possibile ways you can get a little bit more savings out of life you might try thesimpledollar.com.
There are several problems with the idea and that is that most people withdraw from their investments such as their 401ks in a recession when the market is down the most and most people have to withdraw when there is the least amount of available excess cash, and most people are able to invest when they have the most money which tends to occur when there is the most excess near the peak of an economic cycle. Also, most people only look at the expense ratio and are not aware of all the hidden fees. There are many more problems but none of them are insurmountable. The problems can be overcome with the right strategy. You might have cash in different "buckets" and have substantially more cash than most are advised to hold. This will be tempting to deviate from when you have the most cash AND things are going really well but you have to look in terms of percentages of your nest egg/savings and divvy it up so that you have a healthy cash percentage. Most people are told X number of months worth into a cash fund in case you get laid off. That doesn't include the amount of cash you should have to capitalize off of stocks being substantially on sale. It will be difficult for the average person to ADD to the market when prices are the lowest AND have enough cash to weather the storm AND not withdraw from stock accounts when you need money the most AND anticipate declines and have the MOST amount of cash when things are great and least amount invested.
An allocation strategy that is intelligently crafted can provide some help since you will have enough stable assets that do well when times are bad, enough that do well when times are good, and enough that consistently deliver protection of savings and minimal growth so that the losses are not severe.
Take for example the following examples and how they backtested:
(illustrated here)
Strategy 1 I attempted to maximize the "Sortino ratio" a measure of negative deviations.
Strategy 2 I attempted to maximize the "sharpe ratio" a measure of all deviations.
Strategy 3 I attempted to provide the best "Sortino Ratio" possible while still delivering a strategy that was without a single year that produced a loss.
I wouldn't expect historical results to necessarily be as good moving forward. In the past the interest rates were much higher and declining lower to provide a boost in principal to bond holders. Now the money market accounts offer virtually no return and the treasury yield is much lower.
One of the strategies that resonates with me is the one preached by Robert Kiyosaki. I enjoy playing the game cashflow 101 and thinking about treating real life in a similar way. The additional savings can be used to payoff debt and create more savings or acquire new assets to boost passive income, or to trade stocks or invest. Different strategies might work for different situations or match people's personality and risk profile. Some people may be more comfortable with a large amount of savings and taking decisive action when the economy is in a recession and the deal is far better than anything that has previously been available and the deal still allows a person to keep some excess cash to manage possible expenses and they can also take steps to protect against the downside risk Other people just use excess cash at any given time as their protection against risk and a cautious plan all of the time. Some may be aggressive all of the time and just have to endure greater emotional swings and swings in capital and much higher levels of risks.
Some cannot handle loss, others can. Some cannot tolerate working at a job for another 5 years, others can. But regardless of your strategy you must understand their will always be some weaknesses and some strengths. Be very mindful of the weaknesses and make sure you can tolerate it. A more aggresive strategy doesn't necessarily mean a quicker win. If the aggression pays off it willl mean a quick win but if it fails it will be harder to make up for the loss. Increasing the aggression may increase the probability of getting back to even but it also increases the probability of an even greater loss which will take even longer to come back from and it also increases the risk that declaring bankruptcy will be the only available option. A strategy that is cautious may seem like it would take a lot longer, but because there are no large drawdowns from high risk strategies, on average it might be sooner. The aggressive strategies may have a much wider time they take until completion but might be the only way you have a chance at finishing many months earlier.
I personally like the idea of decreasing risk through partners who not only invest but they bring something unique to the table. Maybe one person is an expert in fixing properties, another is great at negotiating lower deals and another has a lot more money but not much time. You can find mutually acceptable terms and risk less money as a percentage of your wealth than you would normally have to and are more able to manage the total risk in accordance to what you want. Owning 10 properties with 10% equity in the results is safer than 1 property with 100% equity since you are forced to live and die by the results of one where as with 10 you can handle cashflow going negative since you have other properties with positive cashflows. You can handle selling for a loss if you simultaneously sell a property at a gain. You can also be in a position where you can afford to invest in a deal AND save some cash on the side or invest it.
There are many different ways of saving or investing. You might just convert your savings into a collection of quarters, dimes, nickels and pennies. A complete coin collection could easily be worth more than the value of each individual piece and can be worth no less than it's value. A quarter is worth a minimum of 25 cents no matter if it is 2013 or 1952. But to a collector an entire set or the missing piece to their set immediately should have more value. Additionally the material used may be such that it costs the government more to make the coin than it is worth and the melt value of the material may be worth more than the designation of the currency. As such it may have value if coins are no longer made of copper, nickel, silver, lead or whatever their material is just as coins made of silver tend to be a lot more valuable now.. It could be baseball cards or rare art. Not all collections work out just as in speculating in the price of silver or the price of a stock.
But if you are going to save money anyways, it might make sense to stash away coins needed for the collection, and spend, invest, or deposit those that you have many extra copies of.
If you are going to eat food anyways, it might make sense to buy in bulk, save a discount, and invest in future food costs now as a savings not only for the bulk discount but also to save on future appreciation and costs. If you are going to fill your car with gasoline and heat your house with fuel it might be wise to set aside a portion of your income to pay for future oil related costs and put it into energy companies and royalty trusts and save the dividends and/or future sale of stock and/or income from selling covered calls for the expense of oil prices while gaining from the companies income over time
To someone who can compound money at a high rate, that additional savings that may result in a few million 20 years from now (if the person is able to continue to generate that excess savings) may not be worth all that much. Afterall, if someone is going to be a millionaire in another 2,3 or 4 years and have those millions continue to grow, then what good are the habits that will take another 20 years to match that, particularly if by then the millions will grow to billions? It may not matter if the person has a can of pop each week, an extra expensive meal once a month, or a night of entertainment every weekend. The one thing you cannot get back is time even though inevitably every moment only becomes a memory and every memory soon too will vanish. Nevertheless, life is a result of all the prior decision we make and the remainder of our life is a result of the decisions we make today. We will spend the remainder of our life in the future and the moment will only be a memory so it's up to you to decide how to improve future moments and how to value present moments.
For some people, being rich at a young age will be much more valuable than at an older age and they may be in a race to become rich in their 20s or 30s. To others they will regret not enjoying their 20s while they could have all so they could be a little bit closer to wealthy or get their in their 30s instead of their 40s. Either way, it's important to understand the results that compounding your savings can have, the impact of compound costs and compound earnings so that you can determine how to leverage these concepts in a positive way to match your goals.
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