Flying business class, golf days and eating at expensive restaurants, this is the millionaire lifestyle idolised by many. But, what doesn’t get talked about enough is how exactly to get there. For some people it feels almost unattainable when in actual fact, with enough time and patience a millionaire lifestyle can be a reality for almost everyone.
As a beginner investor myself, learning about what Warren Buffett calls the 'snowball effect' entirely changed my perspective on this.
The analogy is, if you were to stand on top of a snowy mountain and forge a snowball, then you roll that snowball down the mountain, by the time it reaches the bottom the snowball might look like a small boulder.
Also read: Building a business at uni with just $20
The same can be said about your investing.
Start off with a small sum at a young age and by letting time do its thing, you will see the same effect. This is the essence of compound interest.
A study by Vanguard Australia, showed that if $10,000 was placed in the Australian share market in 1992, by 2022 that same $10,000 is worth around $131,400 with a 9.8 per cent average return for the last 30 years.
"The Vanguard data assumes no transaction costs or taxes and the reinvestment of all income, with a $10,000 investment in 1991."
When you realise that this return is averaged across every natural disaster, pandemic and global financial crisis it paints a pretty good path to success.
As a young person with very average financial literacy, here is how I see the path for any teenager to wants to retire as a millionaire.
Build your snowball
When you’re in your late teens and very early 20’s you have next to zero living expenses, this is the time to get ahead and build your principal.
Get a job, any job, and save as much as you can. It’s realistic at this age to even be saving 50 per cent of your income. The goal is to build up $10,000-15,000 and start your snowball.
Choose a mountain to roll your snowball
Then the next step is to, as Buffett would say, take your snowball, and place it in what is known as an index fund. An index fund is a type of exchange-traded-fund (ETF) which allows you to, instead of buying a few companies (high-risk) , diversify your portfolio across the whole index or certain industries.
And now the goal is patience and to not get cocky and think we can do better than the market. It’s to purely feed our snowball with savings every year, sit back and let time do its thing.
Basic compound interest calculators, like this one from the government, can help any young person fully grasp the power of time.
Some simple maths on the calculator told me this.
If at 20 years old, I had saved up $10,000 and put my money into a portfolio, if I also worked a fairly average job and only managed to save an extra $5000 a year to feed my snowball, assuming the 9.8 per cent market returns for the last 30 years stay consistent.
By the time I had my 51st birthday that portfolio would be worth over $1,055,000. If I left that same money in until the average retirement age of 65, I would have over $4,000,000 in that portfolio.
If you’re prepared to get more hands and use a more active investing strategy, there are Australian investors likeTony Kynaston who has his QAV system, which returns an average of 19.5 per cent per annum, then after thirty years the portfolio should be worth more like $7.4 million.
Obviously this doesn’t factor in taxes, inflation or transaction costs but you get the idea.
It takes most people 20 years to fully grasp and understand the power of compound interest, but it’s clear, time is the variable that matters most.