At a Berkshire Hathaway Inc. (BRK.A, Financial) (BRK.B, Financial) shareholder meeting in the 1990s, when asked what his best advice was for investing and building wealth, Charlie Munger (Trades, Portfolio) said something that has become legendary in the world of finance:
"The first $100,000 is a b****, but you've gotta do it. I don't care what you have to do. If it means walking everywhere and not eating anything that wasn't purchased with a coupon, find a way to get your hands on $100,000. After that, you can ease off the gas a little bit."
Why does Munger consider that first $100,000 so critical? Read on to find out.
The power of compounding interest
Munger stresses the importance of reaching $100,000 as soon as possible because of the extraordinary power of compound interest. Compounding interest is when the returns generated on an investment begin to earn returns themselves. It creates an exponential snowball effect, where money grows faster and faster over time.
For example, say you invest $10,000 and earn a 7% return in year one. That gives you $700 in investment gains, bringing your total to $10,700. In year two, you earn 7% not just on your original $10,000, but on the new total of $10,700. This gives you returns of $749, increasing your investment to $11,449.
In year three, the returns will be even higher, as they are based on the now larger amount of $11,449 rather than the original principal. This cycle repeats, with returns compounding on an ever-growing pool of money each year. The snowball starts gradually but picks up tremendous momentum over time.
The sooner, the better
This compounding effect only starts to reveal itself after a critical mass of savings has accumulated. Munger chose $100,000 because crossing that threshold is when compounding truly accelerates.
To see why reaching that threshold faster unlocks the power of compounding, let's compare two investors, John and Sarah. They both invest $10,000 per year and earn a 7% annual return. However, John manages to hit $100,000 after just five years of saving and investing. It takes Sarah 10 years to reach the same amount.
After hitting $100,000, they stop contributing new money but stay invested. After earning compound returns on a larger sum for 20 years, John's portfolio is worth $386,000. Meanwhile, Sarah's portfolio is only worth $275,000 because her $100,000 has only been earning interest for 15 years, compared to John's 20.
This example illustrates why Munger stresses getting to $100,000 so urgently. The earlier you reach that critical mass, the more compounding can boost your money.
Lifestyle inflation is the enemy
While most people understand the idea behind compound interest, few manage to utilize it to actually grow significant wealth. Why do so many people fail to reach Munger's magical $100,000 number, preventing compounding from working its wonders? The biggest culprit is lifestyle inflation.
As people earn more over their careers, the natural tendency is to increase spending on housing, cars, dining out, vacations and other lifestyle expenses. Munger himself has said, "The first rule of compounding is to never interrupt it unnecessarily." But that is exactly what lifestyle inflation does - it prevents continuous compounding by siphoning away money that could be invested.
For example, consider a 25-year-old named Claire. She starts her career earning $60,000. By 35, through promotions and job changes, she is making $120,000 annually. Rather than keep her expenses fixed, Claire upgrades her lifestyle along the way. A nicer apartment, a new car, fancier clothes, a maid service, weekend trips, the works.
As a result, Claire's savings rate is stagnant. She saved 10% of her income when making $60,000, but still only saves 10% as her salary doubles. Even worse, many people increase their spending as their income rises. So Claire's $60,000 in expenses became $120,000 over the decade. Her $6,000 in initial savings stayed flat at $12,000 annually.
This failure to control lifestyle inflation prevented Claire from getting to $100,000 quickly. After a decade of earning big paychecks, she still did not have enough saved up for compounding to start working its magic.
How to reach $100,000 faster
Avoiding lifestyle inflation is critical to accumulating savings quickly. But you can also take proactive steps to expedite reaching the $100,000 milestone:
- Start early - Give compounding more runway by investing in your teens and 20s. Waiting until your 30s and 40s gives compounding less time to work.
- Invest consistently - Make regular contributions to your portfolio over time, even if small at first. This gives compounding more capital to work with.
- Reinvest gains - Do not spend dividend income or investment profits. Reinvest it to compound future returns.
- Seek promotions - Progress up the career ladder to earn more income that can be invested.
- Get a side hustle - Use a second job or side business to generate extra cash to invest.
- Be frugal - Cut unnecessary costs like eating out, unused subscriptions and expensive hobbies.
- Limit housing - Opt for a small starter home or shared housing rather than overspending on space.
- Buy used cars - Purchase quality used vehicles to avoid auto loans and high depreciation.
- Travel hack - Use points and miles to vacation in luxury without high expenses.
These sacrifices and smart savings strategies will pay immense dividends over your lifetime by unlocking compound interest as soon as possible.
The intangible benefits of reaching $100,000
Aside from making compound interest start working, reaching the milestone provides other intangible benefits.
The first is financial education. Reaching $100,000 requires learning about investing, budgeting and other personal finance skills. Mastering these sets you up for long-term success.
Second is habit formation. Saving, investing regularly and living below your means become ingrained habits after the effort required to accumulate $100,000.
Then there is delayed gratification. Foregoing luxuries in the short term to reach the goal develops discipline and patience, which are valuable traits for all aspects of life.
You also develop a growth mindset. Hitting $100,000 shows you are capable of achieving a lofty financial goal through determination and grit. This empowers bigger future goals.
Further, enduring the volatility required to grow your fortune forges nerves of steel. You do not panic sell during crashes after surviving the journey to $100,000. The ambition and drive needed to reach the goal helps maximize your career potential and income growth runway as well.
Finally, these intangibles will pay dividends throughout your life and finance career after withstanding the trial by fire of amassing the first $100,000.
The journey of a thousand miles
Reaching $100,000 may seem an impossible feat if you are starting from nothing. But remember - the longest journeys begin with a single step. Even if you can only save a few hundred dollars a month now, making every little bit count will get your snowball rolling. Invest those small sums consistently for a decade. Avoid lifestyle inflation. Reinvest all gains.
Before you know it, almost imperceptibly at first, that snowball will have accumulated into $100,000. And that's when the real fun begins. Compound interest will explode your net worth exponentially in the years after crossing that magical mark.
Stay focused on the first $100,000 and do whatever it takes to get there as rapidly as possible. That will set you up to generate life-changing wealth through the snowball effect of continuous compounding.
