I’m always fascinated by what people value. Sometimes they won’t openly say what it is that they value, but you can learn a lot about someone by simply watching what they buy.
For a handful of years, I lived in the NYC area. I was relocated down there for work (in a former corporate job) and spent about 5 years in the “city that never sleeps.”
One weekend a good buddy of mine came to visit. As we were exploring the city we stopped in to the Nike store in SoHo. As we were perusing the merchandise, he was looking at some of the things they had on sale.
He was actually wearing one of the jackets they were selling, and I happen to look at the sticker price of this particular jacket. It was almost $700!!!
But don’t worry, it was currently on sale for about $500. (eye roll)
I thought to myself: “How is this guy ever going to get to a point where he’s financially secure if he continues to buy things like this?
THE TWO PATHS OF PERSONAL FINANCE
In personal finance, there are really only two paths you can take (with plenty of variations and slight differences).
You can take the path of the “spender.” Most people in the U.S. and throughout the world take this path. They earn an income, and the immediately go out and spend that income on whatever it is they feel like doing at that time. It’s a vicious cycle of consumerism that traps in you in a work-earn-spend, work-earn-spend loop.
On the other hand, you could take the path of the “wealth builder.”
On this path, you forego expenditures like a $700 Nike jacket. Instead, you take that money and invest it. Then, when the next big purchase looks you in the eye, you forego that one as well, and invest that money.
In this cycle of wealth-building, you work-earn-save-invest, and repeat. Over time, you build up wealth.
One day, in the future, you’ll have built up enough wealth that the interest and returns on that money is generating more and more money for you. It might be generating so much money you won’t feel bad about using it to buy a $700 Nike jacket…
THE MAGIC OF COMPOUND INTEREST
One of the reasons the path of the “wealth-builder” is so powerful is because of a concept called compound interest. This is the concept that when you invest your money and earn a return, you can then reinvest the return you received and earn additional return on top of it.
If you invest $100 dollars and over the course of the year you get a 10% return (or $10), you’ll be left with a total of $110.
Now, if you reinvest all of that money and again receive a 10% return, you’ll get an $11 return, and now have a total of $121!
So, you got a return of 10% both times, but instead of getting $10 returns each time, the second time around you actually received $11. That extra dollar is the magic of compound interest!
This is called “letting your money work for you.”
If you are spending your money, you will never benefit from that magic. The sooner people realize this, the sooner they begin taking advantage of it and enjoying the benefits.
For my friend, let’s quickly look at the opportunity cost of buying the $700 jacket.
If, instead of buying the jacket he invested that money and let it grow over the course of 30 years at an interest rate of 10%, that $700 would grow to be just over $12,000!
The purchase is costing him a LOT more than just $700. And so are all of the purchases you make without thinking about it.
CAN YOU BUILD WEALTH EVEN IF YOU LIKE TO SPEND MONEY?
This isn’t to say that it’s impossible to build wealth if you like to spend money, it’s just that the amount of income you need to earn has to be so great that it vastly outweighs the amount you’re spending.
And here’s the worst part…
Have you ever heard of the phenomenon called “Keeping up with the Joneses?” It’s the idea that we are constantly trying to keep up with the lifestyles of those around us. So, if you’re seeing your friends and family buying new cars, clothes, etc., you’re going to want to “keep up” with them, so you don’t feel like everyone is doing better than you.
If you are a spender, you’re even more susceptible to falling for this trap.
Another thing that goes hand-in-hand with this is “lifestyle creep.” As we earn more money, we tend to spend more money and get acclimated to the new level of income and spending. Spenders are also more susceptible to lifestyle creep, making it more and more difficult to build wealth.
It’s a perpetual cycle of earn more, spend more, and it constantly acts as a barrier between you and building wealth.
JACKETS FOR EVERYONE!
It’s very simple. You can buy all the jackets you want, and wealthy people can, as well. The difference is that if you use your money now to build wealth it will eventually be the one buying that jacket for you – you won’t be relying on a specific job. The interest pays for all that you need and more.
Once you’ve hit the point where your investments can pay for anything you want, you’ll know you’ve reached financial freedom. Until then, you’ll constantly be making the choice between following the light or dark path of personal finance.