Introduction
Once you have $100,000, your financial world starts opening up. You can start to consider buying a house, investing to generate sizable dividends or passive income, or even buying a small business.
But the first $100,000 is the most difficult to amass. Renowned billionaire investor and vice chairman of Berkshire Hathaway, Charlie Munger, firmly believes in this concept. And he’s not alone.
Today, we’ll uncover the truth behind this belief. What’s so magical about this number, and why is it notoriously difficult to reach? Well, you’ll be surprised to find that this isn’t just a catchy saying; it’s backed by a blend of finance, human behavior, and the power of compound interest.
Difficulties in reaching the first $100,000 Why is getting to that first $100,000 so difficult?
Why is it so hard?
1. The first challenge lies in the very nature of money. Money is a tool, and like any tool, its effectiveness depends on how well we use it. The trouble is, using money effectively is a skill that we aren’t naturally born with.
It’s a skill that has to be learned, and for many people, it’s a skill that’s learned through trial and error. For example, when you first start to earn money, you might be tempted to spend it all. It’s understandable.
You’ve worked hard, and you want to enjoy the fruits of your labor. And the less you save, the longer it takes you to reach that $100,000 mark.
2. Secondly, there’s the issue of financial knowledge. Understanding how money works, how to invest, and how to make the most of your savings are all crucial components in building wealth.
But this information isn’t always readily available or easy to understand. Thirdly, we cannot ignore the impact of income. The amount you earn significantly affects how quickly you can reach that $100,000 milestone.
Compound interest
In your journey to reach your first $100,000, you will come across compound interest. Don’t worry if you don’t; you’re certainly not alone. In fact, a survey by the National Foundation for Credit Counseling showed that only 56% of Americans genuinely understand compound interest.
So, let’s make it clear for everyone. Compound interest isn’t just simple interest plus more interest. Oh no, it’s far more potent than that. Here’s the trick of compound interest: It’s interest on your interest.
That’s right, you earn interest not only on the initial amount you put in but also on the interest you’ve already gained.
So why does compound interest make the first $100,000 so tough to reach?Â
Here’s the thing: compound interest is a slow starter. When you’re only earning interest on a small amount of money, the returns don’t seem that impressive.
But as the amount you’ve saved increases, so does the amount of interest you earn. And over time, this growth isn’t just linear; it’s exponential.
Consider this: if you’ve got $1,000 in a savings account that offers a 5% annual interest rate, that only gives you an extra $50 after one year. However, the following year, you’re earning interest on $1,050, not just your original $1,000.
That may not sound like a big difference, but over time, this pattern repeats and intensifies. Now, let’s apply this to our $100,000 goal. If you’ve managed to save $100,000 and it’s earning a 5% annual interest rate, you’re looking at an additional $5,000 at the end of the year.
Just out of interest! And the following year, you’ll be earning interest on $105,000, not just your original $100,000. You can start to see how quickly things begin to ramp up.
But here’s the kicker: Getting to that first $100,000 can feel like a slog because, at lower amounts, the magic of compound interest just isn’t as noticeable. In the same way, once you’ve saved that first $100,000, the power of compound interest really starts to shine.
You’re earning more interest each year, which in turn earns you even more interest. It becomes a virtuous cycle. But getting there requires patience and discipline.
Because compound interest takes time to work its magic, those early years of saving and investing can feel like an uphill battle. This is why the first $100,000 is often described as the hardest.
Once you get there, however, the next $100,000 is much easier, and so on. $100,000 invested at the age of 25, compounded at 10% until the age of 65, results in a staggering 4.5 million dollars. You don’t have to touch it at all; simply enjoy the magic of compounding.
Our own behaviors
The Behavior Barriers Now, it’s time to delve into another key factor that contributes to the struggle of reaching that first $100,000: our own behaviors. Sometimes we can be our own worst enemies when it comes to financial progress.
But why is that, and how can we turn things around?
Firstly, there’s the issue of financial literacy. Simply put, understanding money isn’t as straightforward as it should be. In a study by the Financial Industry Regulatory Authority, only 34% of Americans could answer four out of five basic financial literacy questions correctly.
This lack of knowledge can lead to poor financial decisions, which in turn make it harder to accumulate savings. But it’s not just the knowledge that’s the problem; it’s also the habits we form around money.
Are you saving regularly, or do you wait until you’ve got some spare cash at the end of the month?
The truth is, regular saving is key to hitting that $100,000 mark, but it’s a habit that many of us struggle to form. According to a survey from Bankrate, 21% of Americans don’t save any of their annual income at all. The difficulties don’t stop there.
There’s a big difference between saving and accumulating wealth. It’s entirely possible to save regularly but still find it hard to reach your financial goals due to a phenomenon known as “lifestyle creep.”
As you earn more, you might start to spend more, upgrading your lifestyle bit by bit.While it’s natural to want to enjoy the fruits of your labor, the trouble with lifestyle creep is that it can eat into your ability to save.
For example, if you get a raise and decide to move into a more expensive apartment, that’s more money each month that isn’t going into your savings. Before you know it, you’re earning more but also spending more, and your savings haven’t increased at all.
It’s a sneaky trap that’s easy to fall into, and it’s a big reason why even people with good incomes can struggle to reach that $100,000 milestone. To make matters worse, spending money often feels like it could be more rewarding in the short term.
We’re wired to seek instant gratification, and saving is anything but instant. It’s a slow, gradual process, and the rewards only become apparent over time.
In the age of same-day delivery and instant streaming, it’s not surprising that many people find saving hard to stick to. But those who can resist the allure of instant gratification and keep their eyes on the prize are the ones who succeed in reaching their financial goals.
The Importance OF Consistent Savings Consistent savings is the fuel that drives your financial engine, and without it, reaching that $100,000 milestone is going to be a tough task.
Consistent savings may sound simple, but it can be surprisingly challenging. Life is full of unexpected costs. Car repairs, medical bills, or even a spontaneous trip can disrupt our best-laid financial plans.
So, the key here is not just to save, but to save consistently, regardless of what life throws at you. Now, you might be wondering how much you should be saving. While there’s no one-size-fits-all answer, a popular rule of thumb is the 50/30/20 rule.
This rule suggests that you should aim to spend 50% of your income on needs, 30% on wants, and save the remaining 20%. Of course, this may need to be adjusted based on your personal financial situation, but it’s a good starting point.
So, how does consistent saving affect your journey to $100,000? Well, to illustrate this, let’s break down some numbers.Let’s say you manage to save $500 a month and invest it at an average return of 10% per year. After the first year, you’ll have saved $6,000. Not bad, but we’re just getting started.
By the end of the second year, you won’t just have another $6,000 Thanks to the 10% return on your investment, you’ll have roughly $13,200. Fast forward five years, and you’d have almost $40,500, thanks to consistent savings and compound interest.
By the end of nine years, you’d have over $100,000. Now, here’s the fascinating part: If you continue with this saving and investment strategy, you’ll have your next $100,000 in just about 6.5 years.
That’s right! It takes a significantly shorter time to earn your next $100,000, thanks to the compounding effect. Of course, these figures can vary depending on your savings rate, your investment returns, and many other factors.
But the principle remains the same: consistent saving is key to reaching your financial goals. It’s the slow and steady method that wins the race to $100,000. So, we see that reaching your first $100,000 is a journey that involves harnessing the power of compound interest, overcoming behavioral barriers, and committing to consistent savings.