Building wealth and financial freedom in your twenties

by seangljacobs

Part of the New Guinea Commerce Winners Don’t Cheat Series.

By Sean Jacobs and Jordan Shopov

For young people today the idea of building wealth can be daunting. Never in history have we been so well off but, at the same time, so overwhelmed by financial advice. A dizzying suite of credit cards, savings funds and mortgage offers mix with technical terms like ‘derivatives’ and ‘negative gearing’ to present a confusing picture of the world of finance.

Ideas like saving and ‘thinking long-term’ in your twenties can be difficult. And, without putting your money to use, a decade can pass with little to show other than a pile of debt. But the path to wealth and financial freedom is made much simpler by considering just three basic steps.

Step one is to avoid debt. The investment legend Warren Buffett says that the biggest suggestion he has for young people is to ‘avoid credit cards.’ It’s simply impossible, he says, to get ahead by paying 16-18 percent interest. To avoid debt some people cut their cards up, others use debit cards (so they actually have the cash first) or just enlist self-control in exchange for impulsive buying and poor decisions.

Step two is to spend less than you earn and invest your savings. Spending less than you earn doesn’t always mean tightening your belt but sorting out what’s central to your life and what isn’t. An education, for example, is probably something you want to spend money on versus a holiday in the Bahamas. And when you take time to examine what you spend money on, versus what you actually need, it’s amazing how much income can be spared.

In terms of investing your savings it’s not optimal to just place cash in a savings account – your money needs to go up in value not just when you work but even when you sleep, eat and relax. Pouring money into a savings account can also be outpaced by inflation.

One of the ways to beat this, over the long run, is by investing in an index fund. As Buffet’s business partner Charlie Munger says: ‘if you consistently spend less than you earn and invest it in index funds… in 20, 30, or 40 years, you can’t help but be rich.’ The secret to this is called ‘compounding’, which Albert Einstein said was ‘the eighth wonder of the world.’ Compounding basically allows you to earn interest on interest. When you add time – something young people have an advantage in – to a good rate of return we have the ‘magic of compounding’.

But today, more so than ever, young people are animated by the idea of instant gratification – wanting something now rather than having to put in the years of hard work. The pervasive use of credit creates a warped picture of wealth where consumption can be done now but kicked down the road and paid for later.

Television shows tell young women that, by writing a weekly column, they’ll breeze through life in a multi-million dollar New York mansion wearing the latest, most stylish and expensive clothes.

Movies, too, sell a popular overnight version of financial success that seems to revolve around speculation (Wolf of Wall Street, Wall Street: Money Never Sleeps), or outright gambling (Runner Runner, The Gambler, 21). It’s easy to be seduced by the financial alchemy of complex algorithms, chart patterns, insider trading, or counting cards. Ultimately, however, it is character that builds real wealth and value in society.

This relates to the third and most important step, and one which many older people say they wish they had in their twenties, which is to operate according to your ‘inner-scorecard.’ In other words, to maintain a consistency between your work, life and core values. This may seem more like a piece of self-help rather than financial advice but the two are inherently inter-connected. Poor life choices and irrational decision making are the fastest track to unhappiness and financial ruin.

Buffett and Munger’s great success, both in life and in business, stem from a complete lack of contradiction between their personal values and life choices. This is why they have often attributed their wealth to a ‘temperamental advantage that more than compensates for a lack of IQ points.’ The goal, therefore, is not to strive for success as measured by others, but to to do the work that best suits you. Wealth is the ultimate by-product of such personal fulfillment.

For those who doubt this mantra, Buffett poses the following question. ‘Would you rather be considered the best lover in the world and know privately that you are the worst, or would you prefer to know privately that you’re the best lover in the world, but be considered the worst?’