I forget where I first heard the phrase, but I’ve become enamored with the idea of dollar bills as “Little Green Employees”. You see, there are a few different things you can do with every dollar that you earn:
- Spend It– instead of a piece of colored paper (or more likely some numbers in a bank account) you trade your money for stuff, experiences, or services.
- Save It– then the money will be available for future spending needs like emergencies or big ticket items (cars and houses).
- Invest It– the real winner here. Use your dollars to create more dollars.
We’ve all got to eat, so some level of spending is inevitable, but economists will tell you that after a certain point, each additional dollar spent is going to give you less value back. Once you have your basic needs covered, you’re better off saving and investing the extra.
Now you could argue that this means some level of sacrifice; after all you’re not buying absolutely everything right now that you possibly could. However, future you is going to be pretty grateful when there’s plenty of money available for needed expenses instead of having to take on debt and live paycheck-to-paycheck.
Save or Invest?
When I first started my career, I was very much in the “Saving” camp. Not necessarily because of a real conscious choice, but mostly by default. I liked the security that I felt in having an increasing bank account balance and at the time the 3 to 4% interest payments each month seemed pretty nice. I also had this (false) impression that investing was only worth it when you were rich and had a lot of money. I thought, “What’s the point in buying stocks if I’ll only get a few bucks a year?”
So, over the first few years of being a real adult I ended up saving over a year’s worth of salary with no real plans of what to do with it. I even opened an IRA because I had been told that was a good idea, but then I failed to invest it for years and just left the money sitting there.
Today, many people are in a similar situation of keeping all of their money out of the market. There’s constant talk about how “over valued” the stock market is since it’s been going up steadily with no crashes for almost 9 straight years. They worry that if they put their money in now, a big crash could be right around the corner and they’ll lose it all.
The simple fact of the matter is that your dollars are best put to use by being invested (in a low-fee index of the stock market). I’ve discussed before how it doesn’t matter if the market drops because you only lose if you sell. Put your dollars into the market and then leave them alone to create income for you.
The market price doesn’t matter when you’re in it for the long haul because over the past 90 years the S&P 500 index has returned an average of 9.8% per year. That’s a whole lot more than any savings account is going to give you, and while it may be a bumpy ride, the inevitable trend is relentlessly upward.
Also, if you’re worried about getting in now while prices are at all time highs, I’d urge you to read the story of the world’s worst market timer.
My approach has been to save enough in my bank account to cover a few months of living expenses or an emergency and then invest every other free dollar.
Little Green Employees
This is what your dollars become when you put them in the market. Instead of sitting idly in a bank account or being given away for more stuff, your dollars act as employees in your own private company. However, unlike human employees, they don’t take time off or browse Reddit during work and they’re earning for you around the clock.
The real beauty of this relationship is that when your dollars are working for you, it requires no energy or time from you. In your regular job, you trade your time and energy for a salary. If you want to earn more, you’re going to have to work harder or longer.
Not so for the little green employees.
As they work for you, your employees will grow and multiply through reinvested dividends and capital appreciation. This means that every year, just by leaving your dollars in the market, you’re getting a raise. The next year your money will earn you more (on average) and these raises will get bigger each year through the magic of compounding.
This is never going to stop blowing my mind.
Let’s look at a quick example of linear growth vs exponential (compounding) growth:
- Linear– I take 30 steps from my front door. After the 30th step, I’m at roughly the end of the driveway.
- Exponential– I take 30 steps, but double the distance for each (1 step, then 2 steps, then 4 steps, then 8, etc). After the 30th set of steps, I’ve circled the planet 26 times.
This is analogous to how your income grows:
- Job Income– Grows mostly linearly. Every year you may get a raise of a few thousand dollars (with some exceptions for promotions or new companies) which may increase a little bit over time.
- Investment Income– Grows exponentially. At first it seems small, but over the course of years and decades these “raises” can become staggeringly large.
In considering how our investment raises grow over time, there’s a handy tool called the Rule of 70. We divide 70 by the average return to calculate how many years it takes to double the investment. With an average return of say, 7% (after fees and inflation), that means your investments will double roughly every 10 years.
This means that while your salary income might grow bit-by-bit, your investments will keep doubling and doubling again, just like in the 30 steps example. Before you know it, your investments will earn you more every year than your regular job does. They become what Joel has dubbed a “Perpetual Money Machine!”
My 2017 Growth
I just got done reviewing my finances for the year and was pleasantly surprised to see how much of an impact my little green employees are having. I’ve been working hard to invest as much as possible over the last 5 to 10 years (since I moved past the temptation to keep everything in savings) and am now putting about 2/3 of my income into investments each month.
At first, this money was only earning me a couple hundred dollars per year; nice, but nothing to write home about. Now, after a few years, my green employees are earning nearly double what I’m able to save out of my income.
And while I have to work 40+ hours a week to get that salary income, those investment dollars just required that I leave them alone to do their thing.
Now, it’s worth pointing out that this ratio is highly dependent on how the stock market is doing. This year, the market grew by a very nice 20%. There will be years when it’s much lower than that and also years where it’s negative. However, given the average 10% growth per year and my consistent use of saved income to buy more investments, this ratio will continue to shift towards “investment growth” making up more and more of my income each year.
Here’s a chart showing the trend in the ratio between investment growth and salary saved. There’s a very clear improvement over time, despite monthly variances in my savings and the market.
These numbers are green employee income compared to what I’m saving from my salary. If I compare them with my full salary (before expenses) the ratios aren’t quite as impressive: investment returns are somewhere between half and 2/3 of what I make in my day job. That said, this is still pretty incredible.
It’s as if I’m making the salary of a way more senior coworker or someone with a whole lot more responsibility and stress. All it took was for younger me to keep expenses low and invest as much as possible. You can do the same thing for yourself! Give future you a raise by investing as soon as possible and consistently adding more over time.
The other fantastic piece is that one day in the not too distant future, my little green employees will be making more on their own than I ever could in my job. At that point I’ll be financially independent and able to give up work entirely or, more likely, do work that I find meaningful and impactful.
On to 2018
It wouldn’t be right for me to close this out without at least some mention of the new year. I’m looking forward to another great year, and regardless of what the market does I’ll be putting more green employees to work. If you’re the sort to make resolutions, maybe consider aiming for a higher percent of your income sent to investments for the year. Alternatively, a nice concrete goal is maxing out your 401k and/or IRA contributions.
Either way, thanks for reading and I hope you have a Happy New Year!