While you can't show off superpowers like Superman or Spider-Man, everyone has financial powers that they can harness. With people living longer than ever, it's imperative to understand and take advantage of these two concepts as soon as possible.
1. Purchasing power
Purchasing power is how much you can buy with what you have. Remember how grandpa said, “back in the day” a dollar could buy lunch, groceries, and shoes for his walk uphill both ways to school? Back then, a dollar had significantly more purchasing power than it does today due to inflation.
If your assets aren't generating earnings, they become less valuable. However, if you invest and earn returns above inflation so your assets appreciate, your purchasing power will increase instead.
Over the last 20 years, inflation has averaged 2.2%, while an average savings account today only yields 0.09%. People that keep everything in a savings account are losing purchasing power. Meanwhile, the S&P 500 has returned 8% annually over the last 20 years, even while undergoing multiple recessions.
To increase your purchasing power, you can also take advantage of the power of compounding. This is when returns are reinvested to generate additional earnings over time, creating an exponential effect.
Albert Einstein called it the eighth wonder of the world, saying, “He who understands it, earns it… he who doesn't… pays it.”
To utilize the power of compounding, you want to target a return that fits your investing goals.
Let's compare two employees: Mark and John. Mark is risk-averse and doesn't understand the concepts outlined above, whereas John does. They sit next to each other at work, earn an identical $48,000 salary that offers a 5% 401(k) match, and both save $500 per month after taxes and expenses.
Mark puts all his money into his savings account earning 1%. Over 30 years, this adds up to $210,000 ($180,000 of which were his own contributions, $30,000 from compounding growth).
While that may seem like a nice increase, John understands the Power of Compounding and Purchasing Power. He contributes $200 of his $500 monthly savings to his 401(k). The company matches his contribution, which is essentially a $200 bonus every month. With $300 leftover savings, he contributes monthly to an investment account. His investments average 7% returns annually. Importantly, John always reinvested his returns and doesn't withdraw anything. After the same 30 years, he has over $853,000.
John saved $180,000 (same as Mark), but also earned $72,000 from a 401(k) match, and over $600,000 from compounding growth!
Two people. Identical situations. Mark was scared to harness his financial potential, while John understood the massive positive impact it has. John didn't do anything fancy, yet he's four times richer than Mark. Work smarter, not harder!
After saving your first $10,000 to cover emergencies, you should be ready to invest in the stock market. First, contribute at least the company-match into a 401(k) if possible. Next, determine the asset allocation that fits you best. If you're new to investing, a target date fund is an effective investing method since it adjusts your allocation for you.
Your purchasing power will erode with inflation if you don't invest. On the other hand, your investment accounts should exponentially increase in the long-term due to compounding.
By understanding these concepts, you can invest wisely and accumulate assets faster than your peers, even without a higher paycheck.
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