“Money makes money. And the money that money makes, makes money.”
Ben Franklin
What My High School Math Teacher Taught Me About Building Wealth
It was towards the end of my senior year in high school. I’d already been accepted into college. Other than my final high school track season, I had an acute case of senioritis. One day in math the teacher made a claim to the class that immediately got my attention. He said, “This may be hard to believe coming from someone supporting a family on a teacher’s salary, but I am close to being a millionaire. We can afford to take expensive vacations during my summers off, and in a few years, although I probably won’t, I could choose to retire early. Would you like to know the math behind how I did this, and how you can do the same?” My interest was immediately peaked as he continued, “In the next few lessons I will show you that with enough time, and through the math of compound interest, a small amount of money invested each month can turn into a large amount of money. By investing as little as $50 per month, starting now, you can be a millionaire well before the traditional age 65 retirement.”
At this point I was sitting up straight in my chair at attention. I was vaguely aware of investing, but at that point assumed that it either took a lot of money in the first place, or gambling on a particular stock and getting rich quickly. Or, working at the right company. This was the mid-1990’s in the Puget Sound area and I was aware of the “Microsoft Millionaire” phenomenon. It had not occurred to me that it was possible to build significant wealth as a middle class professional.
Here was the example that my teacher gave:
- Invest $50 per month every month.
- Invest that money in an equity mutual fund. Never sell it.
- Earn 12% total return per year. (Note – this is really high but in the mid-1990’s was close to the long term average.)
- At age 63 (45 years later for us 18 year olds) you will be a millionaire.
By saving just $50 each month throughout his working career the fictional 63 year old in his example has $1,072,000!
I was blown away. This simple example remains one of my most vivid classroom memories of my school years. It was arguably the beginning of my interest in the career I ultimately pursued and helped to shape the beginnings of what became my philosophy on wealth and investing.
How Does This Work?
Let’s dive into this example a bit and discuss how this can be implemented in a practical way and with a more realistic example. First, some important caveats from the vantage point of my now middle aged self:
- The teacher made clear at the time that this was just an example of the math, and that he had invested significantly more than $50 monthly by teaching summer school for most of his career. (That part of the story was an important learning for me in itself.)
- The 12% rate of return is much higher than I recommend assuming. You would likely be disappointed. From a mid-1990’s perspective it didn’t necessarily seem high, but this is not a return I would use in financial projections.
- There is no accounting here for taxes or investment costs.
Let’s consider a more robust example assuming $500/ month savings and an 8% total return on investment. Here is what your balance would look like over 30 years:
The reason this works is due to the exponential growth potential of compound interest. In the early years this is hardly noticeable, but over time most of your wealth will come from the growth of your investments rather than your contributions. By year 30 you have invested $180,000 and have $565,00 of gains! These gains were generated by your money working for you. No wonder Albet Einstein called compound interest the eighth wonder of the world.
Focus on what you can control.
You may have noticed that for this to work, there are three different factors at play. The amount you save each month, the assumed rate of return, and how long your return compounds. With enough time, even a relatively small amount of savings (like the $50 per month from my teacher’s example) can turn into significant wealth. The earlier you start investing the better you can take advantage of the magic of compounding. Notice that in the chart above the really big gains happen later in the 30 year period. Of course, investing more each month will help you accelerate this process as well.
The one factor that is out of your control is the rate of return you earn on your investments. Depending on your asset allocation (mix between stocks, bonds, and other investments), the timing of when you start, future earnings growth, taxes, investment costs, and many other factors beyond your control you may earn more or less that 8%. I will write about all of these factors in future posts. The point is that while how your investments perform in the future is mostly out of your control, by focusing on what you can control (the amount invested, remaining invested through ups and downs in the market, and holding your investments for the long term) you will have the best chance of success.
While there are many paths to wealth, and certainly no guarantees, the get rich slowly method taught to me at age 18 is arguably the simplest and most accessible for the majority of the population.
