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The Magic Money Box that doubles your cash every 10 years

How many times have you been told that it’s important to start saving for retirement as soon as you enter the working world?  I had heard this conventional wisdom over and over again, but I never really believed it… that is, until I ran some of the numbers myself.

How I used to think…

So let me explain how I thought saving for retirement would work.  I figured that I should spend most of my entry level paycheck and save a little for emergencies.  Then I’d grow my career and eventually start saving for retirement once I was “in the money”.  This seemed to make sense, and allowed a good number of frivolous purchases.

My logic went a little something like this.  I don’t make a lot right now, so saving now wont make an impact.  Once my salary is so much higher, I will be much more effective at saving.  This theory seemed pretty sound, and there’s certainly some merit to it.

Saving 50% of your salary when you make $55,000 is certainly more effective than saving 50% of $40,000.  In that scenario, I’d have to save much longer while making $40,000 to build up the same savings… so why not wait?

The answer: I was missing one very important factor in my money equation.  The Time Value of Money.  I know this is a simple concept to most experienced (or even amateur) savers, but it blew me away once I really ran the numbers.

The Time Value of Money

Basic financial theory states, money today is worth more than money tomorrow.  My initial assumption was that money today was worth about the same as money next year, since banks paid me almost nothing to hold it, and it didn’t seem to grow on its own… This never really bothered me until I started saving real chunks of my cash.  I suddenly needed to take advantage of this money building phenomenon.

I’m going to assume that by putting my savings into a broadly diversified index fund, I will yield 7%/yr (a big assumption, I know).  In other words, I’m going to put whatever I save into a big money box with a question mark on it, and then let it sit for 10 years.  After 10 years of gathering dust, I decide it’s time to open the magic money box, and low and behold, every dollar I put in there gave birth to another dollar.

So even though I didn’t actually do anything with that money, the magic money box caused it to double in value. (in fact the companies I invested in are doing a lot to grow the money)  This is why my initial assumption about being able to save later in life is incorrect.  Every extra dollar I am able to save when just out of school, is actually worth two dollars 10 years later.

Mastering The Magic Money Box

So as long as I’m saving close to 50% of what a bring in, I’d only have to build 10 magic money boxes.  That is, one a year.  And then on the 11th year, I’d take the doubled money out of the money box, use half for spending, and create another magic money box with the other half.

Now, I know it’s not really that easy, but once I was able to think about it like that, I could truly appreciate investment returns.  It really helped me to understand how somebody could one day become financially independent (in as little as 10 year).  After doing the math, I’m not sure I’m going to get there in just 10 years, but by saving about 50% at the beginning of my career, even if things don’t go as well as I hope they do, I can’t imagine needing to work longer than 10 years.  Retiring at 45 doesn’t sound so bad!
That’s not to say you can’t start later, but putting off saving, will only put off financial independence!  So I figured, why not give it a shot.

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