A central theme to WELLth’s culture is our focus on making small, positive changes to better financial futures. These small changes, like using a credit card with a rewards program instead of a debit card, add up over a long time period to make a significantly positive difference in your overall net worth. This post explores why that is the case, and why today’s seemingly insignificant decisions will greatly impact your financial wellness decades later.
Exponential vs. Arithmetic Growth
The phrases “exponential growth” and “arithmetic growth” are two mathematical terms which determine how any one thing grows. Arithmetic growth means that growth is constant in a fixed amount, and not a constant percentage.
For instance, if your job which currently pays you $75,000 promises to give you a pay raise over $2,500 every year, your salary will exhibit an arithmetic growth pattern. On a graph, this pattern is easily identifiable – it’s a straight line.
Exponential growth, using the same salary example above, would mean that your salary would increase by a fixed percentage rate. Let’s take the above example, with someone’s starting salary at $75,000, and grow it at a 3% rate per year.
The raise in year one was the same with both arithmetic and exponential growth, $2,500. In spite of this, after 30 years, the annual salary on the exponential growth curve was $32,045 greater than the arithmetic curve.
The telltale sign of exponential growth is that the curve, as noted in the graph above, begins to bend upward. Growth accelerates, and in many cases, the curve starts to look like the letter “J”. In the chart below, I’ll show both of the graphs above, with one more curve showing annual raises of 8%.
The difference is staggering. Therefore, we can maximize our wealth by placing our financial selves in exponential growth situations as frequently as possible. Sadly though, annual raises of 8% a year is unrealistic for most of us. Therefore, it is difficult to take advantage of exponential growth with our salaries. Saving and investing, however does create exponential growth.
A Real-Life Scenario, Investing in the S&P 500 Index Since 1990
In the graph below, I take a hypothetical investor who invested $100,000 in the S&P 500 Index (stocks) at the beginning of 1990 and reinvested any dividends which were paid. By the end of 2019, their money grew to $1,851,605, a 1752% return over 30 years. The stock market’s ascent actually happened, and despite the market inevitably having bumps and hiccups along the way, you can go to many thirty-year periods over the last century and find similar patterns.
Patience is a Virtue, and Consistence is Key
In most of the exponential growth charts I’ve displayed in this post, you can see that the charts really don’t “take off” until the middle or the end of the chart. That’s not to say that the small changes in the beginning are not important. In fact, those changes at the beginning are the most important, for they set the stage for a steep J curve to form at a later date. What about that $150 you invested each month by only buying clothing that was on sale? You’re probably not going to see a big difference in your net worth over the first few years. In fact, after two years at an 8% rate of return, you will have only increased your net worth by $4,066. After twenty years, however, this small change in shopping habits will have made you $89,093 richer and $225,194 after thirty. Therefore, patience and consistence are paramount to success.
Conclusion: Multiply Yourself
A previous mentor of mine, who was a legend in the hedge fund world for his pioneering market research, once gave me a piece of advice. “Want to get rich? Multiply yourself.” He told me that I could only earn so much in so many hours during a day. By investing, however, I was “multiplying myself,” creating exponential growth opportunities by owning the stocks and bonds of companies which were growing exponentially and then reinvesting my profits. I impart the same wisdom to you. Adopt small habits, small positive changes, and they too will multiply, and lead you to financial plenty.