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Recently I had a conversation with a doctor about two ways to create a large net worth. The doctor already had one thing in her favor, and that was a strong income.
But her concern was what to do about investing. She had already paid off hundreds of thousands of dollars in education loans and now wanted to invest for her future.
I’ve spoken about this before, but I found it is a very, very bad idea to delay investing by paying off debts first. Your CPA, or a financial planner, might think that’s a good idea based on the difference in rates.
Your CPA, Suze Orman or Dave Ramsey might say paying off an 18% credit card makes more sense when you compare it to earning 8-12% on some investment. (We can talk about how you get those returns some other time, and you can.)
Unfortunately, they are looking at numbers and not people. People are not numbers, nor are people devoid of feelings. And feelings run the show most of the time.
If you wanted to build muscles, you would start lifting weights, or do some other resistance exercise. If you changed your diet, and I don’t care what eating program you pick, no matter what diet you followed you cannot build muscles without also doing the exercises.
The focus on paying off debt is like a focus on dieting, and it has the same roller-coaster effect. You lose some weight, you go back to the old habits, and it comes back again. You pay down some debt, something happens and it comes back again. You are neither building muscles nor building your net worth.
The only way to grow your net worth is to start a savings and investment program, NOT focus on paying off debt.
When your net worth gets large enough the earnings can pay down, and pay off your debts. This is what I did, and it works. I will explain after a few more paragraphs.
Now to the subject line of this email: Linear investment growth.
As an oversimplification, there are two ways to grow your net worth: Linear or Exponential.
For linear growth, you put away some amount of money over time and it grows based on the impact of compound earnings. It works, and it is slow due to the time factor required. You need time to see the benefits of this approach.
For exponential growth, you ought to be actively involved in the investment (or have a partner or partners), and value is added to the investment. This could be real estate, a business, or active stock investing.
This is what I did with the apartment building investments: My $18,000 investment grew to $125,000 in six years based on a single three-unit property. That’s about 34% compounded annually.
With my two partners, we would just rinse and repeat. We looked for buildings that had deferred maintenance and were mismanaged. In eight years my original $18,000 was worth about $926,000 tracking that one investment.
I continued making the minimum payments on my credit cards and poured all my extra money into investments instead of paying down debt. I also borrowed money to make down payments on more apartment buildings. Now the income from my investments pays both for my standard of living and any debt payments.
There are some other strategies we used, and we grew from our original three unit purchase to 50 units in about 7 years. I call that exponential. My net worth went from near zero at age 50 to multi-millions.
To do the same thing using a linear approach would have taken consistent earnings of 10.5% compounded over 38 years. With that approach, if I could get a consistent 10.5% return, I would have been 88 years old. And the $926,000 would not be worth the same 38 years in the future as it was 7 years in the future. (This is the time value of money concept.)
Are you wasting precious time paying off debt instead of growing your net worth? What could you do instead?
To Your Prosperity,
Rennie
