Building a wealth snowball

Building a wealth snowball

To conclude “back to basics” month at Get Rich Slowly, today we're going to explore an important concept, one that's new to most people. Today, I want to talk about building a wealth snowball.

After nearly twelve years of writing about money, I've gone from not knowing anything to having some very strong opinions.

I now believe know, for instance, that the single most important thing you can do to improve your financial situation is also the most elementary: Increase the gap between your earning and spending.

Spend less than you earn — that's the basic rule of personal finance.

People don't want to hear this. It sounds too basic, too facile and simplistic. It's reassuring to believe that the answer to your financial woes is somehow more complex. It isn't. The answer to every financial problem is to increase the gap between your earning and spending. (The complicated part, the tough part, is developing the skills and mental fortitude to make this happen.)

If you spend less than you earn, you'll build a wealth snowball that will allow you do do the things you dream of doing and to have the things you dream of having.

What on earth is a wealth snowball? It's the ever-increasing stash of cash you have in your banking and brokerage accounts as you boost your saving rate and earn returns on your investments. Your wealth snowball is your nest egg, your net worth.

To better explain the wealth snowball, it might help to first review the concept of the debt snowball.

The Debt Snowball

Most of you are probably familiar with the debt snowball. This term — popularized (but not invented) by Dave Ramsey — describes a method for rapidly repaying debt. Here's how it works:

  • Let's say Jim is in $20,000 debt. The minimum payments on his debts come to $500 per month. Each month, he pays this $500 total toward his debts.
  • When Jim repays his first debt, let's say one $100 minimum payment disappears. Now his minimum payments total $400 per month. With the debt snowball, however, Jim doesn't reduce his debt payments to $400. He keeps them at $500 per month, applying that extra $100 beyond the minimum payments to the debt of his choice.
  • Now let's assume Jim pays off a second debt, eliminating one $120 minimum payment. Now his minimum payments total $280 per month. Again, Jim keeps his total debt payments at $500 per month, throwing an extra $220 per month at whichever debt he chooses.
  • This pattern continues until all of Jim's debts have been repaid. He never drops his debt payments below $500 per month, even when his total minimum payments are far lower.

With the debt snowball, the order in which Jim repays his debts is irrelevant. (With Dave Ramsey's version, you repay debts with low balances first. There are other ways to order the debts, though.) What matters is that as you eliminate each debt, you keep your total debt payments steady. Doing this creates an ever-accelerating snowball of debt reduction.

To make the snowball even more powerful, Jim could add to his total monthly debt payments. Imagine he gets a $200 per month raise at work. Instead of spending that money, he could add it to his $500 debt payment to achieve a total of $700 per month in debt reduction. In this manner, his debt snowball can become an unstoppable force.

Snowball by Kamyar Adi

Life After Debt

But what happens once Jim is able to get out of debt? What happens when he no longer has debt payments and suddenly finds himself with an extra $500 in cash each month?

For folks who take the view that debt reduction is a goal and not a side effect, there's a real danger that this money will now be used to fund consumerism — and that this consumerism will snowball too, leading them right back into debt. I've seen it happen.

But debt reduction is an outcome and not a habit. As such, I think it makes a sub-optimal goal. Better instead to focus on the habit that leads to debt reduction. That habit is saving. That habit is creating a gap between your earning and spending.

For Jim to be able to pay $500 toward his debt each month, he had to increase his earning and decrease his spending until he had enough cash to make the payments. It's this action — spending less than he earns — that should be Jim's goal, not debt reduction. Debt reduction is merely a side effect, an outcome, a result of implementing a smart action.

If instead of focusing on debt elimination as a goal, Jim instead pursues the gap between his earning and spending, he puts himself in a terrific position to enjoy other positive side effects once his debt is gone. Perhaps the best of these side effects is the reverse of the debt snowball, the wealth snowball.

The Wealth Snowball

Now let's imagine that Jim had never become focused on debt elimination as a goal. Let's imagine that he always viewed it as a side effect, and that he (rightly) kept his attention on his saving rate.

Once Jim has finished his debt snowball, once he's repaid his $20,000 in debt, he now has $500 per month to do with as he pleases. Because Jim is a smart fellow, he decides to build a wealth snowball. Here's how it works:

  • Jim opens a retirement account. Because he reads Get Rich Slowly, he knows how to invest. He takes the $500 per month he had been using to repay debt, and now he puts that money into an index fund at Vanguard (or Fidelity).
  • Whenever Jim has a chance to work overtime, he works overtime. He doesn't spend that money, but puts it toward his new wealth snowball. Same thing whenever he gets a raise: He invests that money for future growth.
  • Jim looks for ways to economize, large and small. He bikes to work during the summer. The money he saves, he invests. He and his wife move to a smaller home, one with a smaller mortgage. He invests the difference between the old payment and the new payment.

Jim does what he can to increase the gap between his earning and saving, because he's come to understand that his saving rate is the key to building an enormous wealth snowball. If he can invest $1000 per month, his wealth snowball grows twice as quickly as if he were to invest $500 per month.

Because I'm lazy and don't want to make a new graph, I'm going to re-use the same graph I used in yesterday's article about how to invest. Although the numbers are different than the ones I've been using for Jim, the idea is the same. Let's assume Jim's wife Jane invests $5000 per year for 45 years and earns an 8% return on her investments. Here's how her wealth snowball would grow with time.

Pretty amazing, huh? Jane contributes $5000 per year for 45 years. That's a total of $225,000. In the end, her investments are worth ten times what she contributed! That's the wealth snowball in action.

The Shockingly Simple Math of the Wealth Snowball

This concept is what Mr. Money Mustache has famously referred to as the shockingly simple math behind early retirement. Look at these numbers.

  • With a 10% saving rate, you need to work for 50 years to save enough to afford to retire. Your wealth snowball grows — but not quickly.
  • With a 20% saving rate, you need to work for 37 years before you'll have saved enough to retire.
  • With a 35% saving rate, you need to work for 25 years to achieve Financial Independence.
  • With a 50% saving rate, you only need to work for 17 years before you can retire.
  • And if you can manage to save 70% of your income, you could retire in 8-1/2 years!

The “shockingly simple math” is true even if you have zero desire to retire early. Whatever your goals are, the more you're able to save, the quicker you can achieve them.

This isn't magic. It's not a scam. It's math. It's the wealth snowball in action.

The sooner you grow your wealth snowball — and the bigger you grow it — the sooner you can do the things you dream of doing.

Last week at Of Dollars and Data, Nick Maggiulli shared another benefit of a large saving rate: As you increase the amount you save, your investment returns become less important. Here's a graph from Maggiulli's article that demonstrates this phenomenon:

The more you save, the less the market matters

If you only save 10% of your income, then the growth of your wealth snowball is largely at the mercy of market returns. If the stock market has several good years in a row, your wealth snowball embiggens. If it has several bad years in a row, your wealth snowball remains roughly the same size.

But if you save half your income, for instance, market forces have a minimal impact on how quickly your wealth snowball grows, how quickly you can achieve your financial goals. Sure, there's an impact, but because you're saving half your income, that impact is much smaller than it is for your friends who are saving less.

A Call to Action

My not-so-secret wish is that every reader of Get Rich Slowly would make it their personal mission to increase their saving rate, to widen the gap between their earning and spending so that they could build ginormous wealth snowballs that allow them to pursue their purpose.

For readers who already save, my dream is that you would save even more.

For readers who are in debt, start where you are. Rearrange your life to achieve a positive cash flow, then use that positive cash flow to build a debt snowball. When you've used that debt snowball to crush your debt, do not stop. Keep that snowball rolling, but now use it to build wealth.

The journey may seem difficult now. I get it. But I believe in you. You can do it. Wherever you are, whoever you are, you too can build a wealth snowball if you try.

More about...Debt

Become A Money Boss And Join 15,000 Others

Subscribe to the GRS Insider (FREE) and we’ll give you a copy of the Money Boss Manifesto (also FREE)

Yes! Sign up and get your free gift
Become A Money Boss And Join 15,000 Others
guest
24 Comments
Oldest
Newest Most Voted
Inline Feedbacks
View all comments
Church
Church
2 years ago

I love this article because it contains the secret recipe that the 1% don’t tell the 99%. The 99% refuse to listen because it isn’t as sexy as crypto or fintech IPOs right now. And so the constant struggle continues.

Per the example, “Jim” unlocked the secret…”he’s come to understand that his saving rate is the key to building an enormous wealth snowball”

Thanks for sharing!

Carlos SlimShady
Carlos SlimShady
2 years ago
Reply to  Church

“The 99% refuse to listen because it isn’t as sexy as crypto or fintech IPOs right now. And so the constant struggle continues.” Umm what? I am sure it has nothing to do with racial and gender pay gaps or banks not giving mortgage or small business loans to minorities. You do know that participating in an IPO typically requires 6 digit net worth. Using the number of accredited investors in the US as a proxy, that is only 12 million people in a nation of 300M+ who could participate in “fintech IPOS” and the financial background of these people… Read more »

Keith
Keith
2 years ago

However much other people make or own affects you not a bit. Same for whoever has access to an ipo. The key – as every financially literate person knows – is save as much as you can as early as you can and invest in a diverse index fund – ideally total stock market or SP500. You will grow wealthy and will not need to be angry at successful people.

Inf
Inf
1 year ago
Reply to  Keith

Very well said Keith……..100% agreement with that.

Garrett Skikolski
Garrett Skikolski
1 year ago

Jeez man. He’s not saying occupy Wall Street. He’s simply making fun of those sketchy articles and pamphlets you find preaching the “14 Secrets Wall Street Bankers Don’t Want You To Know”.

Joe
Joe
2 years ago

High saving rate is the key when you’re starting out. It’s going to take a while, but you have to keep at it. Once you’re in the habit, then it will keep rolling automatically.
At this point, our annual returns far outweigh our annual savings. Our snowball has momentum now and it won’t stop anytime soon. I’m so glad our saving rates were high in our 20s.

Teress S.
Teress S.
2 years ago
Reply to  Joe

In our mid-40s, we’re in the same place as you, Joe. Our savings from current income is a drop in the bucket when compared to the annual profits being produced by our investments. The power of compounding makes saving and investing in your 20s and 30s far more valuable than saving and investing in your 50s.

S.G.
S.G.
2 years ago
Reply to  Joe

It’s a completely alien feeling when you realize that youre no longer in a pool where you create the flow, and you are on the ocean and just riding the waves.

BucketBabe
BucketBabe
2 years ago
Reply to  S.G.

GREAT imagery there. 🙂

Steveark
Steveark
2 years ago

Can’t do it myself but I know great writing when I see it. I do love reading your work J.D. because I really want to develop a readable style of my own some day. I’m slightly early retired and the side gigs I started to keep my brain challenged are keeping me at a zero withdrawal rate. It was easy to figure out how to spend when we were rolling that wealth snowball downhill. Now I’ve been rolling it for the last two years for no real reason. My wife and I are content with our old used cars and… Read more »

Jake
Jake
2 years ago
Reply to  Steveark

Steveark- You have good writing. Keep at it.

Rachel
Rachel
1 year ago
Reply to  Steveark

What a beautiful place to be in! Congratulations to you and your wife! Do you have a charity/mission that you’re passionate about? Maybe you could find an avenue for your wealth that would bring you joy where more stuff won’t. I love missions like Heifer International that provide animals to families in need, teach them how to take care of them and build sustainable incomes for that family and their communities by passing offspring of the original animal on. You could find organizations that work with affordable housing or clean water or help fund kids going to college. Even donating… Read more »

freebird
freebird
2 years ago

Einstein’s eighth wonder of the world really is a thing. It’s actually a double whammy, when you save more not only does your stash grow faster, but your spending also stays suppressed so you need a smaller nut to last forever. IOW when you save more not only does the ball fly farther, your goalposts also move closer! The reduced sensitivity to subpar investment returns when you boost your savings rate is a point that’s rarely explained, and is also something I can attest to. I’ve done well over the years and I thought it was my investment prowess, but… Read more »

Michael
Michael
2 years ago
Reply to  freebird

Maybe I am wrong but, I dont think he was saying you couldn’t beat the market. My takeaway was when you let someone else manage it and they charge 2% it is hard for them to beat an index that charges almost no fees. Because now your not trying to beat the market its you’re trying to beat the market +2%. Also, Just because you beat the market doesn’t mean your right. An index is going to be more diversified than a single stock so while you could put all your money on x and easily beat the index if… Read more »

JoeHx
JoeHx
2 years ago

I love the use of the snowball analogy on the other side of debt – on people’s investments and savings. It works so well because the math is essentially the same. Once I pay off my debt, I intend to move the snowball payments towards investments, which is part of the reason I sometimes include my debt payments when I calculate my savings rate.

JSE
JSE
2 years ago

When I was in graduate school, the financial aid department said a powerful statement that changed my view on saving and spending. They simply said “if you live like a doctor when you are a student, you will live like a student when you are a doctor.” I worked multiple jobs throughout school (and after), drove a used car and didn’t spend on what I didn’t need. I paid off my undergraduate and graduate school loans off in 4 years, and am 22 months away from paying off my business loan. I have no other debt other than a mortgage-… Read more »

brian @ singledadmoney
brian @ singledadmoney
2 years ago

Nice write-up JD. My focus has been increasing my savings rate and when I finally became debt-free, that snowball money automatically switched from debt to wealth and is now building my emergency fund. I run an annual budget (broken down into 26 paychecks), so I know when the switch “should” happen. Sometimes life gets in the way and the should-happen date slides to the right a little, but the budget is easy to adjust. Right now I’m saving about 22% toward my emergency fund and 7% toward investing. Once my e-fund is fully funded, that 29% savings rate (or more… Read more »

Jason@WinningPersonalFinance
2 years ago

I love the concept of a wealth snowball. It’s a beautiful thing when your assets make more money than you do selling your time. You explained it perfectly. I do take exception with one point though. You said, “For readers who already save, my dream is that you would save even more.” I disagree a bit. At some point, you are saving enough and it’s even possible to save too much. For each of us, that amount or percentage may be different. At some point, it’s more important to use your income/assets for “their purpose” than it is to continue… Read more »

Jake
Jake
2 years ago

I don’t think there’s such thing as saving too much. I do, however, think that you can save “too much” in a 401k since you “can’t” touch it until retirement. I recently scaled back on my 401k contributions, and upped my taxable brokerage account contributions. This allows me to have some flexibility with regards to pulling some money out prior to retirement. Basically, I have an old man’s account(401k for retirement), and a taxable account to dip from in early retirement- assuming that I’m able to retire early.

Accidental FIRE
Accidental FIRE
2 years ago

The snowball is indeed powerful. It’s essentially driven by compounding interest, where each turn of the snowball now has a bigger base and picks up more snow. Simplicity, power, and results.

Jaime
Jaime
2 years ago

Okay I’m really confused J.D. are you an editor? Did you buy back GRS? What happened that made you come back? Just curious. I used to love to read GRS before you sold it and I’m so happy to see you’re back. =)

Ms. FI-ology
Ms. FI-ology
2 years ago

I love this article and concept. Especially where you say, “Better instead to focus on the habit that leads to debt reduction. That habit is saving. That habit is creating a gap between your earning and spending.” I have spent the last 4 years doing the debt snowball thing. I also got sober 8 years ago so I knew ALL my habits had to change. Fortunately, this included increasing the gap between earning & spending. Now that I just entered the accumulation phase, I want to apply that same % that was going to debt to wealth building (wealth snowball).… Read more »

Dave
Dave
2 years ago

Great article. The snowball can be positive or negative. We can snowball our savings or our debt. One can always reverse the debt snowball as well.

shares