When you haven't got much capital of your own, the road to financial security can seem long and arduous. But the truth is that wealth building is actually pretty simple.
All it takes is time and the price of a cup of coffee.
Most of my kid’s friends are just out of uni. They are still in their early 20’s and generally they have quite big HEC’s debts to pay off. They certainly have little savings capacity.
One of these kids (we’ll call him Matt) was over on the weekend. We were having a chat over an espresso. He has acquired quite a taste for the stuff while studying and has worked out that at my place, they are free J.
"How much do you spend on espresso each week?" I asked him. After thinking for a moment, he replied that he averaged about two cups a day, depending. We worked out that equated to about $40 a week or $160 a month.
"Well, what if you sacrificed the coffee and put the cash into a savings scheme instead?" I suggested.
Matt looked at me funny. He doubted kicking caffeine would be easy, but what really surprised was that he could not imagine that loose change spent on coffee would make a realistic difference to his long-term financial position.
We then began a discussion about the miracle of compounding.
With the use of my trusty financial calculator, I showed him that a monthly contribution of $160 per month and earning interest at 5%, his coffee money would gradually accumulate to a pool of a quarter of a million dollars by the time of his retirement. And this was without saving another cent.
We did some other numbers too. If he put his education to good use and got a well-paid job, he could conceivably bump that up to $500 per month. His savings pool then would grow to three quarters of a million by his retirement. And this was a conservative estimate.
This sounds too easy, he said. That's because it is easy, I replied. The interest he earned on his saving was paid into his account and included in the next calculation. So he was earning interest on interest.
The key was that firstly he was starting early. Secondly, he was saving a small amount consistently month after month. Thirdly, he was exercising patience. The rest of it was just the effect of time and compounding.
(Obviously, Matt's earnings will be subject to tax. But the purpose of this exercise was to show him that a small sacrifice, made regularly, would yield significant results over time.)
We called it his 'espresso strategy'. Kicking the caffeine habit may be hard but will be made up for by the slow roast of a savings scheme that promised him riches at retirement.
Even for those of us much older than Matt, there are lessons here. We tend to underestimate the effect of gradual saving and patience in building wealth, just as we tend to over-rate gimmicks promoted in the media.
We can't control the ups and downs of markets or the daily noise of the media. We can control our own behaviour. With slow and steady saving, and a trusted advisor to keep us disciplined, there is no reason we can't succeed.
Now enough of this money talk. Who’s for a coffee?