Long Term Thinking

Building Wealth – Part 4

Thinking in long term helps us to make informed decisions. Bill Gates once famously said, “Most people overestimate what they can achieve in a year and underestimate what they can achieve in ten years.” With the plans that we have put in motion now, we all have a rough idea of where we are headed in next year. But not many of us are capable of thinking where we would be in the next 10 years in terms of career growth, income growth or net worth growth. 

Building Wealth Part 1:
Developing Financial Knowledge

Building Wealth Part 2:
Delayed Gratification

Building Wealth Part 3:
4 Phases of Building Wealth

It helps to have a rough map of where we are headed in the long term. Of course, nothing will go exacly as per the plan. But in our journey, at least we will know how we are doing compared to our base line plan. 

Possibilities in India

For good long term planning, we need to understand the possibilities in the long term. If we have ₹10 Lakhs available now for investing, is it possible to grow that money to ₹100 Crores in our life time? When we see a number like 100 crores, we immediately laugh and say no, thinking that it is impossible.

Let’s do a quick experiment to check your exponential thinking capability. If you invest ₹1 lakh now and if that one lakh doubles every 5 years, how much would you have by the end of 50 years? Take a guess and write your guess down on some paper.

If you have read the “Power of Compounding” post, you would have answered immediately that 1 Lakh would have grown 1000 times to 10 Crores by the end of 50 years. 

For an investment to double every 5 years, we need a growth rate of 15%. If you are wondering whether it is possible to achieve a growth rate of 15%, Indian stock market Index Sensex has grown at a rate of 16% in the last 43 years.

If we include the dividends, then the return would have been 17-18%. So a total return of 15% return is not impossible. If ₹1 Lakh can grow to 10 Crores in 50 years, then you can imagine the growth of its multiples. ₹10 lakhs would have grown to 100 Crores in 50 years with no additional investment. 

So if we have saved and invested ₹10 Lakhs by 35 years old, by 85 we could potentially have ₹100 Crores. That 100 crores does not look that big at all now, does it? It is an achievable target in our life time. 

I am giving this example to show the possibilities. For estimation purposes, it is better to assume 10-12% growth every year, or even less, depending on our risk profile.

When it comes to investment, we should start thinking in long term. For a given return rate, how much would our invested money have grown in 5 years? 10 years? 20 years? 50 years? Use the compound interest calculator to get a rough idea of what to expect in the future. 

Thinking in long term helps to make the right decisions now. Without knowing the growth potential, we will be tempted to spend it all now. When we understand the opportunity cost of that spending and the long term growth potential of that money if saved, we can make an informed decision on whether to move forward with that spending or not. This will also help us think twice before jumping on certain life style upgrades. 

Rule of 72

There is an easy way to calculate the long term growth potential- the Rule of 72. This rule basically tells us on how long it would take for an investment to double. When 72 is divided by the expected return rate, we get the years it takes for our investment to double. If our return rate is 12%, then 72/12 = 6 years will be the time period it takes for our investment to double.

If the return rate is 15%, then our investment would double in 5 years. Depending on our targeted return rate, we should be able to calculate how long it takes for our investment to double. Once we know that, we can easily plan for our growth down the road in the future.

Possibilities in USA

We now know that Rs. 100 Crore is possible to achieve in India in our life time. How about the US? In US, we see a million as a very big amount of money. As the popular saying goes, the first million is the hardest- the rest is easy.

Minimal Investor has explained very well on how we could have achieved 1 million in the last decade with an example. If planned right, a single income family can achieve 5 million by retirement age. A double income family can achieve 10 to 20 million.

In fact, an aggressive saver and a smart investor could even make 1 billion in their life time. What does our brain think immediately after hearing the word “1 billion”? It must  be saying – “Impossible- there’s no way”. That is because we have not trained our brain for long term thinking yet.

Lets take a look at an extreme example now. I am calling it extreme because it is a rare combination – an aggressive saver and a smart investor. I am giving this example just to show the possibilities, not to give false hope.

Just as Minimal Investor shared in his post, if we have started at 30, we would have 1 Million by 40. Let’s say, that by that time we have gained enough financial knowledge to know how to achieve 15% growth rate, yeah, that’s a pretty big if. But I already told you- this is an extreme example. 

If our investment is growing at the rate of 15%, our investment would double every 5 years. Then how long would it have taken for 1 million to grow 1000 times to 1 billion? Like we already saw, it would have taken 50 years. Yeah, we will be 90 by then. I don’t know about you, but I am planning on living at least till 100. So 1 billion in our life time is possible. Is it possible for everyone though? No. Because achieving 15% return rate comes with its own risk. We will see about that more in future posts.

The reason I am giving this extreme example is to show that millions or billions are not as big of a number as we think. A normal person with focus and determination can achieve this in their life time. We don’t have to invent anything ground breaking to achieve that. 

When we know our long term potential and understand the long term impact of each financial decision that we make now, we put ourself in a huge advantageous position. Start tracking your networth every year and identify your growth rate. Project that growth to next 10 years and more. If the growth is not to your expectation in coming years, then either reset your expectations or change your long term strategy.

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