The guaranteed secret of wealth — by Noel Whittaker
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Noel Whittaker is the author of Wills, Death & Taxes Made Simple and numerous other books on personal finance. Email: [email protected]
I recently had the honour of addressing doctors at a medical conference in Queenstown on building wealth. I’d like to share with you a part of what I told them.
The secret to a financially secure retirement is to accumulate a pool of capital. If you arrange your affairs properly and use the right investment vehicles, it will go on forever, increase continually, require minimal effort on your part, and be taxed at a much lower rate than income from personal exertion. But how do you build up sufficient investments to provide an income you can live well on?
The answer is by understanding the mathematics of compound interest. In 1748, Benjamin Franklin said, ‘Time is money,’ and this applies to both borrowing and investing. Suppose you had a loan of $800,000 on a 30-year term; your repayments would be $4800 a month, and over that 30 years you would pay back a whopping $930,000 in interest. The long-term means time is working against you. If you increased the payments to $6800 a month, you would reduce the term to 15 years and the interest by $520,000. Interest on your home loan comes from after-tax dollars, so for a doctor in the top tax bracket, a saving of $520,000 after-tax dollars is equal to a boost in gross income of $982,000. The interest saved is equivalent to an extra $65,000 a year in gross income over 15 years.
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Looking at the other side of the coin, you can see the exponential effect of regular investment. To make time your friend when investing, you need as long a term as possible. You see, compounding takes time to work its magic, but the effects grow faster and faster as time passes.
Think about a 30-year-old professional who has $100,000 in superannuation. If they are in the top tax bracket, they will pay a 30% contribution tax, so yearly tax-deductible contributions of $30,000 will add only $21,000 to their super balance after the entry tax.
If they put their faith in compounding and set up a direct debit to ensure that $2,500 is transferred from their bank account every month into superannuation, I can assure you they won’t miss it. And it’s a tax deduction. After five years their super should be worth $270,000 – no big deal – but after 10 years they will have cracked the half-million-dollar mark, which is a nice nest egg for a 40-year-old. On their 50th birthday, the balance should be $1.4 million, and the earnings in that year should now be over $100,000 – nearly five times their net contribution. The compounding process is now feeding itself. At age 60, they will have $3.4 million, and at 65, a huge $5.1 million.
I went on to explain the essential ingredient of wealth building, which I have always called ‘the guaranteed secret of wealth’: the easiest way to get ahead financially is to make investing the first expense out of your pay packet, and not something you try to do with what’s left over. This takes advantage of our propensity to get paid, pay our commitments, and spend the balance.
To give an example, back in 1980 everybody paid their home loans monthly. That is until I stirred up the banks by telling people – on national TV – that they could save a fortune in interest if they made their payments weekly or fortnightly, instead of monthly.
Think about a couple paying $4000 a month on their home loan. If they changed their payments to $2000 a fortnight, they would pay an extra $4000 a year without feeling it: there are 12 months in the year, but 26 fortnights: each year, they make one extra payment. And because that money comes out before they even see it, the extra payment is painless.
Becoming wealthy is not rocket science – all you need to do is adjust your home loan repayments to the level suggested above, put a direct debit in place for your monthly superannuation contributions, and leave the rest to the magic of compound interest.
Advice given in this article is general in nature and is not intended to influence readers’ decisions about investing or financial products. Always seek professional advice that takes into account your personal circumstances before making any financial decisions.
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