There is a good chance that you have heard about compound interest being a surefire method to become financially independent. Perhaps you have heard about millionaires who manage their fortunes through compounding. While the latter is certainly true, the former depends on various parameters.
Planning for Future Financial Comfort
A young investor in her 20s has a good chance of becoming a millionaire later in life if she is able to do the following:
- Deposit a large sum of money into her compounding portfolio.
- Open a high-yield savings account.
- Make cash contributions to her account with highly disciplined frequency.
- Increase the amount of contributions throughout her life in order to offset inflation.
- Live within her means.
If you are able to check all the boxes above, you could become a millionaire in a couple of decades. Naturally, some of the boxes are more difficult than others to check, particularly the large deposit and living within or below your means. In many cases, compound interest investors end up getting into heavy debt with a financial burden that is higher than what their compounding portfolio can generate.
Investment Strategies Generating Passive Income
Compound interest investors who augment their strategy with a financial plan and passive income are more likely to generate a comfortable net worth. The financial plan needs to be more pragmatic than lofty; in other words, it makes more sense to set an objective of completely eliminating debt in a few years than planning on buying a luxury car. As for passive income, it needs to be an activity that can generate money without forcing you to become 100% involved in it. This is easier said than done because even being a landlord can take up considerable dedication unless you can afford to hire a property management company.
A more realistic scenario of passive income would be to engage in activities you can do in your free time; for example, becoming an Uber driver, but this will have to match the goals in your financial plan. If you are staring down at costly debt, paying it off with additional income would be the most logical thing to do because your net worth will always be dragged down by debt.
In the end, you can always be ahead of the game by setting financial goals and seeking extra income to combine with your compound interest strategy. Keep in mind that the time value of money runs on a declining trajectory, which means that the funds you generate today will not be worth as much in the future.