Formula for Wealth

The Formula for Wealth

Life is a journey, not a destination.

- Ralph Waldo Emerson

In the contemporary world, complexity is on the rise, and it's effortless to become overwhelmed by the constant barrage of information. I firmly believe that we have forgotten to focus on the basics. Therefore, I am a strong advocate of simplification. Presenting complex concepts in a straightforward manner helps me remain focused on asking the right questions and deriving appropriate actions.

I often hear the phrase, "There are a million ways to make a million." This statement is entirely accurate. However, I wanted to provide a simple representation of the factors that lead to prosperity. There are precisely three crucial factors, and they form the formula for wealth:

Wealth = Savings x Return ^ Time

These three significant levers profoundly influence the outcome. Each lever has an impact on the result.

Savings:

By savings, I refer to both current savings and the current savings rate. An individual generates a certain income from which expenses are deducted, leaving the savings. To increase this savings rate, one can either increase their income, reduce expenses, or both.

However, both of these options have limitations. One can only reduce expenses to a certain extent, as certain basic needs such as food, transportation, and other necessities require expenditure. Similarly, income is also constrained. You might wonder why I believe income is limited. This is because I view income as one's professional activity and the salary received as compensation. While this salary may be scalable, it is not infinite.

For instance, an entrepreneur can potentially increase their income significantly, but doing so requires investments in their business. Consequently, the income generated from these investments becomes more like the Return on Investment (ROI) of the saved money, which has been strategically put to work.

This brings us to the next point…

Return:

The return describes the growth rate of the capital accumulated through the savings rate. If one does not invest their savings, the growth of their wealth remains linear. In contrast, investing leads to exponential wealth growth.

Linear growth through saving vs exponential growth through saving and investing. (8% p.a.).

In fact, without investment, the return on simple savings can even be negative due to the loss of purchasing power caused by inflation.

There are various paths to generate returns and build wealth, each with its own opportunities and risks.

One avenue is starting and running one's own business. Alternatively, investing in established businesses or ventures can also yield returns through dividends, capital appreciation, or partnership opportunities.

Education and personal development can be a valuable investment, as acquiring specialized knowledge and skills can open doors to higher-paying careers and lucrative opportunities.

Time:

The final significant lever is Time.

Time refers to the duration of saving and the duration over which the accumulated savings grow due to returns. Time is an incredibly powerful lever. The savings rate and return can be relatively small, but having ample time can still lead to substantial wealth.

The significant challenge with time is its limitation. Once it's gone, it cannot be reclaimed, and none of us knows how much time we have left.

Now that we have understood the three major factors for wealth creation, what is the key takeaway?

We have three levers that we can incorporate on our journey to prosperity: Savings Rate, Return on Investment, and Time. Personally, I consider Return on Investment as one of the most crucial levers. While there are examples of highly-paid CEOs who can build wealth over time even with a subpar return, such individuals are rare.

The power of Return on Investment lies in the compounding effect. A small initial sum, when multiplied by a high return, eventually outperforms a larger sum with a constant savings rate. In the long run, it becomes nearly impossible to catch up to the compounding effect merely by increasing the savings rate.

Comparing $10,000 compounded at a 30% annual return with $100,000 compounded at an 8% annual return along with additional savings of $12,000 per year.

Therefore, I firmly believe that only a portion of one's wealth should be allocated for speculation. Eventually, the compounding effect will surpass the gains from long-term oriented saving and investment plans. By adopting this approach, one can engage in speculation while maintaining a manageable level of risk.

When we observe wealthy individuals on this planet, we realize that they did not become rich solely through savings. Instead, they leveraged their resources to generate returns that made them prosperous.

In conclusion, the key takeaway is that focusing on a high Return on Investment, taking advantage of the compounding effect, and making strategic use of resources can lead to significant wealth creation. It is not merely about saving, but also about wisely investing and putting money to work in ways that have the potential to yield substantial returns over time.

By embracing these principles, we can forge a path towards financial abundance and navigate the complexities of the modern world with confidence. Remember, the Formula of Wealth empowers us to take charge of our financial future and build a solid foundation for lasting prosperity.

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