Why Net Worth Goes Crazy After $100k!
Charlie Munger, the celebrated billionaire investor and former vice chairman of Berkshire Hathaway, maintained the perspective that amassing the first $100,000 is the most challenging aspect of wealth-building.
This sentiment is shared not only by Munger but also by many individuals who have successfully grown their fortunes.
A similar notion is often expressed regarding the attainment of the first million dollars.
Once you've crossed the $100,000 threshold, progressing to $200,000, $300,000, and beyond becomes considerably easier.
The momentum gained from reaching your first million typically accelerates the path to the second million compared to the journey toward the initial million.
While this insight may offer reassurance to those diligently working to expand their wealth but feeling discouraged by the slow pace, it underscores the importance of persistence and gradual progress.
Reason 1: Your Earning Power
So, why is reaching the first $100K the toughest milestone?
Well, there are two primary reasons for this.
First, consider it like your level in a video game.
You simply haven't had enough time to develop your skills, so you're not yet on par with the more seasoned players.
This analogy holds true for earning money when you're young.
What's more, this challenge is becoming even more pronounced.
A recent study revealed that Gen Z has approximately 86% less purchasing power than the boomers did at the same age.
This is partly due to older individuals remaining in the workforce for longer, making higher-paying positions scarce.
However, it's not all negative news.
The internet provides an excellent opportunity for younger people to earn significantly more money than previous generations, as many older individuals struggle to navigate platforms like Instagram or TikTok, let alone establish an online side hustle.
In the realm of technology, there aren't many boomers who can keep pace with the younger generation.
Reason 2: Lack Of Compound Interest
The second reason why the initial $100K is the toughest to accumulate relates to the lack of compound interest.
Picture your money as a snowball rolling down a hill.
As it rolls, it gathers more snow, symbolizing compound interest.
The larger the snowball, the more snow it accumulates, thus generating more compound interest.
Sounds promising, doesn't it?
Well, yes and no.
Let me explain.
If you currently have less than $100K, your snowball isn't substantial enough to gather significant income through compound interest.
Essentially, you can't fully benefit from it.
For instance, imagine you invest $10K in an S&P 500 Index fund and earn an average yearly return of 7%, which is historically expected.
After five years, your $10,000 investment would grow to $14,176.
That's a gain of $4,176 over five years.
That's why reaching the first $100K is so challenging.
It's more about how much you can contribute to your investment pool rather than relying solely on compound interest.
This means you'll need to find ways to increase your income.
Personally, I can relate to this struggle.
I recall juggling multiple side hustles simultaneously just to earn enough money.
Working long hours and resisting the temptation to splurge on vacations and fancy restaurants can be exhausting.
But believe me, it's worth it, because once you reach that initial $100K milestone, growing your wealth becomes significantly easier.
Why Does Net Worth Go Crazy After $100k?
So, what's the deal with net worth skyrocketing after hitting $100K?
Well, it's all about compound interest suddenly becoming your best friend instead of just a boring concept.
Let's break it down with a simple example.
If you invest $10K annually with a 7% average yearly return, reaching from zero to $100K will take you about 7.84 years.
But here's where it gets interesting:
Going from $100K to $200K will only take around 5.1 years.
So, you'll need about 2.74 years less to make the second $100K compared to the first.
That's a whopping 35% faster!
And the trend continues:
- From $200K to $300K, it's about 3.78 years,
- then 3 years from $300K to $400K,
- and just 2.5 years from $400K to $500K.
We could keep going, but you get the gist.
The chart starts to go wild, but it all kicks off after reaching that initial $100K.
So, the key is to hustle and aim to reach that milestone as quickly as possible.
Imagine if you could shave off a couple of years from reaching $100K—just think how much faster you'd become a millionaire!
Once you hit this point, becoming wealthy is almost inevitable, especially if you invest in a low-cost index fund.
To put it into perspective, even if you only saved up $100K and invested it in an S&P 500 Index fund without adding anything more, you'd still become a millionaire in approximately 33 years.
That's the incredible power of compound interest once you've crossed that $100K threshold.
Step 1: Budgeting Your Finances
So, how can you reach your first $100K?
It's simple, really.
Just follow these five steps.
I've personally done this myself, and it really helped me during those early stages of building wealth, so I hope it works for you too.
The first step is taking control of your finances.
And the best way to do that?
Budgeting.
Yes, I know, budgeting can sound restrictive, but trust me, it's not about taking away all the fun.
Think of it more like a roadmap that guides you towards smarter decisions.
I'm not suggesting you need to become super thrifty, but it's important to distinguish between your needs and your wants.
And by the way, in case you are not aware, I made a completely free spending tracker for you to help you get to your first $100k faster.
The tracker follows the 50/30/20 rule and also updates real-time as you fill in the numbers to let you know whether you are on track with the goals you set.
So if you want it, just click here to get it!
Step 2: Investing Your Money
Step Number 2 is all about investing your money wisely.
I like to use Interactive Brokers for this but any broker that’s suitable for you will do.
Now, let's do some math.
Imagine you invest $250 per month in an S&P 500 Index fund and earn an average yearly return of 7%.
After 40 years, you'll have a whopping $656K.
But here's the truly impressive part: $536K of this comes from compound interest alone.
That means you've only contributed $120K yourself.
I understand if you're thinking:
But won't I be retired and enjoying my golden years by then?
I get it.
That's why it's crucial to start investing as early as possible to maximize your returns.
Now, if you are completely new to investing, I just made a video going over everything you need to know here as a complete beginner, so be sure to watch it here after finishing this.
Step 3: Optimizing Your Taxes
Now that your income is increasing, it's time to focus on the third step: optimizing your taxes.
It might sound a bit humorous, but the key here is simple: minimize your tax bill.
Let me be crystal clear: tax avoidance is perfectly legal and a strategy employed by financially savvy individuals.
Tax evasion, however, is illegal, and that's not what I'm advocating here.
You might argue:
But if you're earning more, shouldn't you pay more taxes?
I agree with you.
The wealthy do contribute the bulk of tax revenues.
However, there should also be incentives for entrepreneurship, as entrepreneurs create jobs for society.
And fortunately, there are.
Entrepreneurs are taxed on their profits at the end of the fiscal year, allowing them to deduct legitimate business expenses.
These deductions are known as write-offs.
This differs from employees who are taxed on their monthly salaries.
Let's say you're passionate about the latest tech gadgets, like the newest iPhone.
You could start a YouTube channel reviewing tech products.
Once your channel starts generating income, you can deduct the cost of your tech purchases from your profits, effectively obtaining them tax-free.
In essence, the government subsidizes your tech purchases through tax deductions.
However, it's crucial to note that these deductions must be justifiable business expenses.
You can't simply claim any expense without a legitimate business need.
This is why aligning your business with your passions can be an effective way to minimize taxes.
Step 4: Clearing Your Debts
Moving on to step 4, which involves clearing your debts.
Did you realize that the average American carries a debt of $21,800?
If you find yourself in debt, you're certainly not alone.
It's crucial to list out all your debts as soon as possible and prioritize them based on their interest rates.
This is usually called the debt avalanche method.
You could learn more about the 2 different ways of clearing debt in this video here, it’s called Debt Snowball Vs Debt Avalanche.
But start by addressing the debts with the highest interest rates first.
This is where compound interest can work against you if you're not careful.
Picture it like the scorching sun melting away the snow you're trying to gather to reach your first $100K.
If you're burdened with too much debt, it will impede your progress toward financial freedom.
My advice here is to make small payments whenever feasible, as every bit helps.
Don't become discouraged, though, because ignoring your debts will only lead to more stress down the road.
So, even though it may feel like you're losing money with each payment, consider it an investment in reaching your first $100K.
Step 5: Starting Your Side Hustle
Step 5 involves exploring extra sources of income, commonly known as starting a side hustle.
In 2023, around half of Americans have some form of side hustle, even if they already earn over $100K per year.
Engaging in a side hustle offers several benefits by diversifying your income streams.
This diversification provides you with more funds to allocate to tax-advantaged accounts, thereby increasing your investments.
Essentially, you're adding more snow to your snowball, allowing compound interest to work its magic.
Which, as I have mentioned, is a crucial component of accumulating your first $100k.
Once you reach that, you could consider slowing down slightly according to Charlie Munger.
And that’s it, if you enjoyed this article, be sure to share it around with your family and friends.
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Thanks for reading, cheers!
- Ivan