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A Cup of Coffee and the Power of Compounding Interest

Posted by Jamie Downey  March 2, 2009 09:35 AM

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Regardless of your income, obtaining a significant amount of personal wealth is much easier than most people think. Although winning this week’s Mega Millions jackpot sounds enticing, it is not going to happen. The way to become wealthy is to continually set aside a small amount of money and let it grow. With the help of compounding interest, one is almost guaranteed to become a millionaire using this method. The reason most of us do not succeed using this method of generating wealth is that it takes years and persistent sacrifice. Instead we want instant wealth, something which is very difficult to obtain.

Last week the Governor of Massachusetts proposed raising the gasoline tax. He assured us that it will only cost us an additional cup of coffee every week. Although this may seem like a minor sacrifice, let us consider the cost to a driver over his lifetime.

A friend of mine’s son just received his driver’s license. Let’s call him Winston. I estimate that a cup of coffee costs $2.50 and will go up by three percent each year due to inflation. Assume that Winston does not have to pay the additional $2.50 in gasoline tax per week, and instead sets this money aside into an account earning a ten percent annual return. Over the 60 years or so that Winston drives his car, he will amass approximately $611,000, or well on his way to becoming a millionaire. Obviously for a family of three or four, your family wealth will be well into the millions.

The brilliance in Winston’s ability to generate wealth is his long time horizon and his constant contributions to the account. With a 60 year horizon, his money will enjoy exponential compounding effects. Although most of us do not think 60 years into the future, it should make us all think about small sacrifices and how significant they can be over the long term.

Our esteemed state officials like the simplicity of the fast food analogy in reference to the various tax and toll increases being set forth. The Governor uses the cup of coffee analogy. Last month the head of the Massachusetts Turnpike said one of their most recent increases would cost motorists only the equivalent of a turkey sandwich. Do not be fooled by this nonsense. If instead of making these small sacrifices to the state of Massachusetts in the way of increased taxed, you set this money aside for yourself, you will be well on your way to becoming personally wealthy.

This blog is not written or edited by Boston.com or the Boston Globe.
The author is solely responsible for the content.

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ABOUT MANAGING YOUR MONEY
Local finance professionals share insights and advice on issues such as budgeting, managing debt, and retirement planning.

About the contributors

D. Abraham Ringer is a CERTIFIED FINANCIAL PLANNER practitioner and a Financial Adviser with Morgan Stanley Global Wealth Management in Boston. He is registered in MA, NH, NY and several other states to which his articles are directed. For more information please visit www.morganstanleyfa.com/ringer
Financial Planning Association™ of Massachusetts has 900 members who specialize in the financial planning process. Many of its members engage in philanthropic pro bono work in their communities, recommend legislation, elevate public awareness, promote financial literacy, and advocate for sound economic and tax policies.
Odysseas Papadimitriou is the founder of CardHub.com, a credit card and gift card marketplace, and WalletHub.com, a personal finance site. He has more than 13 years of experience in the personal finance industry, and previously served as senior director at Capital One.

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