This is a collaborative post.
While squirreling away cash for a rainy day can sometimes be a good strategy, the best savers are also big spenders. Instead of putting notes under the mattress, they buy things that will make them more money in the future.
Whenever you put money into a savings account, that’s essentially what you’re doing. You’re not actually saving money at all. Instead, you’re giving it to a company that puts the capital to good use, generating returns.
There are many examples of this in action. Some institutions, for instance, do what banks used to do. They use the money you deposit to make loans to other people, charging interest, and then passing on the new income to savers. Other people invest in some kind of asset, like a property or a stock, and then use that to generate more income.
This type of saving allows you to compound your gains and avoid inflation eating away at your wealth. You’re not just working for an income that you spend every month. Instead, you’re getting extra money, financed by the cash you’ve already saved and put to good use, according to Plenti.
The truth is that many of the world’s most successful frugal individuals use this method to build their savings. They’ll invest an initial lump sum and then leave it to start generating more profits over time. Eventually, the amount of money they have in the bank can double, even if they don’t put in any additional savings.
The Power Of Compounding
Investors often talk about a concept called compounding. But what is it? And how can it help you reach your savings goals?
Compounding is a term people use to describe the effects of allowing interest on savings to accumulate over time. Whenever you receive an interest payment to your savings account, you add to your capital, which, in turn, increases the amount of interest you receive. Over time, this process accelerates, leading to massive – sometimes unbelievable – gains.
Let’s say that you’re in your early twenties and you decide to invest $2,000 per year for five years until your mid-twenties and then never save any money after that. $10,000 isn’t much to retire on, so most people would assume that they need to continue saving money throughout the rest of their working lives to retire.
That, however, isn’t the case. If you just allow the money to accumulate interest at, say 12 percent per year, you wind up with more than a million dollars in your account by the time you come to retirement age. And remember, that’s with saving only a small amount of money. If you increase your savings beyond that, you can wind up with considerably more.
Interest Payments That Exceed Your Annual Income
Let’s say you earn $40,000 per year. Imagine if you could earn that money passively, without even having to spend a day on the job. That’s one of the benefits of compounding. And it’s actually easier to achieve than you might imagine. All you have to do is find the right investments.
Suppose for instance you work hard for many years and save as much of your money as you can. You build up $400,000 and use it to buy a property in cash. If that property yields a 10 percent return, that’s $40,000 per year going directly to you, without you having to go to your day job.
Now suppose that you carry on working and earning your regular $40,000. That’s $80,000 in personal income every year which you can then use to build your savings pile even faster or, perhaps, buy another income-generating property.
How Long Does It Take To Double Your Savings?
How long it takes to double your savings depends considerably on the interest rate. If you buy the stock market, you’ll get around an 8 percent return per year, which means that your savings will double roughly once per decade.
If you go into the loans business, your savings will usually double every twelve years or so. And if you find investments that generate 20 percent per year, you can double them in less than four years.
Once you understand the power of compounding, you realize that it has the ability to transform your life. The goal isn’t to make your income higher and higher every year – it’s to build a lump of savings that generates income for you. If you’re frugal, the amount of cash your investments make will increase year on year. It seems magical, but it’s just mathematics.
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