Warren Buffett is the most recognizable investor ever. Even if you know nothing about investing, you still know who the Oracle of Omaha is. He started investing at the age of 11, sometimes joking that he started too late, and has been investing ever since, for more than eight decades now.
When you hear “Warren Buffett”, you almost immediately start thinking of the world’s other richest people, a list he’s been near or at the top of for quite some time. But there’s a big difference between him and many others on that list.
Unlike the Bezoses, Musks and Zuckerbergs of the world, Buffett didn’t earn his wealth by creating innovative companies. He didn’t invent the world’s largest social network, a global e-commerce giant, or the possibility of life on Mars. Buffett’s success has been due in part to his ability to identify the people and the companies that will. The bottom line is that Warren Buffett is a great investor.
Being able to find the right companies to invest in has definitely helped Buffett along the way. Of course, not every company he’s invested in has worked out the way he hoped. That’s just the way life goes. But picking companies hasn’t been Buffett’s key to success.
Over everything else, the key to Warren Buffett’s success is time.
The chart below starts at age 30, when Buffett had a net worth of around $1,000,000. As you can see, there’s basically no visual change at all until about 25 years later. Even the change we can see, from $1 million to $1.4 billion (an increase of 1,400 times), looks microscopic next to his net worth of $137 billion at age 93.
Approximate figures based on published estimates, such as Forbes. More than 99% of his wealth came after his 50th birthday.
This chart spans more than six decades, and over that time, more than 99% of Buffett’s wealth was created after his 50th birthday.
You might be thinking, ‘He’s Warren Buffett, that’s an unrealistic comparison!’ Sure, it’s tough to compare anyone to the greatest investor of all time. But anyone can apply Buffett’s approach, and invest for a long period of time.
In the chart below, someone invests $200 every two weeks and earns 8% a year. We see very similar results to Buffett’s chart: 92% of the total wealth was created in the last 30 years. In Buffett’s case, 97% of his wealth was created over the past 30 years.
Contributions total $312,000 over 60 years; the rest is growth. Assumes a steady 8% return, compounded every two weeks. Illustration only.
Both charts have a similar pattern, with growth starting small but becoming exponential in the later years. These results aren’t due to picking the right companies, timing the market, or taking on unreasonable risk. They’re due to the same thing as Buffett’s results: time.
We don’t have to be Buffett to get Buffett-like results. We just have to put our money in a position where it can work for us, for as long as possible. Simple as that.
How long we’ll actually invest for
Both charts above run for 60 years, and you might be thinking, ‘I’ll never invest for that long; I plan to retire in 30 years! Buffett is only still investing because he’s rich!’
There’s a big misconception that we invest until we retire, and then stop, and that from that point on we only have the amount we retired with to withdraw from, until our money is gone. But that’s not the case. Or at least, it doesn’t have to be.
Let’s say someone is about to retire with $1,000,000, and over their retirement they’ll need to withdraw $50,000 a year to afford their ideal retirement. They have a choice: they can keep their funds uninvested, or invest them to earn, let’s say, 3% a year.
- Earning 4%Lasts nearly 38 years
- Earning 3%Lasts 30 years
- Earning 0%Runs out at 20 years
Withdrawals at the start of each year, before tax and inflation. Illustration only.
If they don’t invest their money, they run out of funds in 20 years. After those same 20 years, earning 3% a year would still leave them with a balance of $422,287, and they wouldn’t run out of funds until the 30th year, increasing the lifespan of their funds by 50%. Earning 4% a year would stretch the lifespan of their funds to nearly 38 years.
With life expectancy and the cost of living continuing to rise, making the most of our retirement funds is more important than ever. When we think about how long we have until our ideal retirement age, plus the length of our retirement, investing for 60 years looks pretty realistic. In some cases, 60 years might not be long enough.
The reality many Canadians face
So far, things seem pretty simple, right? To grow our money and retire comfortably, all we need to do is invest for a very long time. But there’s a big problem: this is far from what most Canadians actually do.
Most people don’t start investing early. They wait too long, which shortens the time their funds are invested for. That means their money isn’t in a position to work as hard for them as it could have. Instead of a 60-year timeline, they might be looking at 30 or 40 years. And we now know that without a long timeline, we’re removing the hardest-working years for our money.
Surveys like Manulife Bank’s 2022 Spring Debt Survey show some startling, but common, statistics. No matter which survey is conducted about the state of Canadian finances, it paints the same picture: Canadians are generally underprepared for their financial future.
This lack of preparedness stems from a lack of financial education at any level. If you’ve made it this far in this article, you’re doing something about it. But at a real-world, practical level, our financial health depends largely on the way we manage our money. And that management usually takes the form of a budget.
Why traditional budgeting falls short
There are multiple ways to budget. Unfortunately, the traditional idea of a budget falls short. When you think of a budget, you likely think of a spreadsheet: reviewing your bank account and credit card statements, and filling in columns of information to track where your money goes. It’s cumbersome and time consuming.
Traditional budgeting doesn’t prioritize our future selves. Putting money aside for our future is often the last thing we look at. We prioritize our now money: non-discretionary things like bills and living expenses, and discretionary things like shopping and services. If we spend all of our money in the present, we shrug it off and tell ourselves we’ll save some money next month. But we won’t.
Our finances are tied to us on an emotional level. Especially when we’re first starting out, it’s likely we’ll make mistakes and miss our goals. Like building a habit, it takes time and commitment. If our goal is to save money for our future, but it’s the lowest priority in our budget, the thing we get to last, it’s unlikely we’ll meet that goal. In that sense, a budget can become very discouraging, and something we don’t want to do at all. So we usually don’t.
A lot of people have a hard time with budgets because the idea of a budget we have in mind isn’t the best it can be. It’s like trying to communicate today using only a fax machine. You’d give up; I know I would. We have to combine our best intentions with the best practice.
That’s why it’s worth rethinking what a budget is, what it’s supposed to do, and how to lay it out in a way that sets us up for the most success.
What a budget should do
A budget shouldn’t be an exhausting tool for tracking our everyday spending. We all have different priorities when it comes to spending. We could read a hundred articles on exactly how to structure our budget, and it’s likely none of them would truly reflect our situation.
A budget should be the balancing factor between our present and future selves. It’s how we divide our income between what we want now and what we want most. It should be effortless, and fit into our routine with ease. Ideally, it wouldn’t take up any time at all. It should be manageable, realistic and achievable, all to keep us committed to it.
With any budget, there’s going to be sacrifice. Prioritizing spending now means sacrifice in the future, while sacrifices today can secure the financial future you dream of. It’s a balancing act. The statistics we keep seeing in surveys show a lack of discipline and planning, resulting in future sacrifices people don’t see coming. Given the choices and results in an easy-to-understand way, many people would adjust their spending habits to put more priority on their future self.
Simply keeping track of our spending doesn’t make us better off financially. Someone could record every transaction in a spreadsheet, but that doesn’t mean they’re going to save and invest for their future, or that they’ll have confidence in their financial future.
If that’s all understood and agreed on, our income (after taxes) can be divided into three categories: now money, buffer money, and Buffett money.
Now money
Our now money is the money we need on a day-to-day basis. It covers things like our mortgage or rent, monthly bills, groceries, fuel, our unique priorities, and our fun money: the financial obligations we can’t afford to miss, because we count on them.
We all have different priorities for what we spend our money on, and understanding that is important. Within your now money, you might spend a lot more in certain areas than someone else, but that doesn’t mean it’s a poor decision. If it’s set up properly, you should be able to spend your now money freely, within reason so you can maintain your lifestyle, and without having to fuss over how you spend it. It should be aligned with your priorities and interests.
Buffer money
We started this article by looking at how Warren Buffett built his wealth: not by being the greatest stock picker ever, but by making sure his investments could work for him uninterrupted, for a very long time. That time is Buffett’s biggest key to building his wealth.
Buffer money is the money that sits between your now money and your investments. It’s the money that helps you work towards your goals, while protecting your investments and allowing them to do what they do.
Your buffer money could take the form of an emergency fund, ideally three to six months of living expenses, or even more if your income fluctuates significantly. It can also be your short-term goals account, accumulating for trips, upgrades around the house, or a future big purchase like a car. It covers purchases and expenses that fall outside of our day-to-day spending, but don’t have the long time horizon needed for investing.
Because of the shorter time horizon, buffer money shouldn’t be invested aggressively, and won’t earn the big returns over decades. But its value is that it lets the rest of our money be invested aggressively over the long term, earning those big returns.
Buffett money
Our Buffett money is our long-term investments. If Buffett’s key to success is time, then we want our Buffett money to stay invested for as long as possible. That’s one of the reasons having buffer money is so important. We want our Buffett money to be in, and stay in, a position to earn as much as possible, for as long as possible.
When we talk about financial planning and goal setting, long-term goals are measured in decades, not single years. That gives us more opportunity to take on volatility and risk. The chart below shows the range of annualized returns the S&P 500 has delivered over different periods of time.
Each bar spans the worst and best average yearly return across every rolling period of that length, with dividends reinvested. The longer the holding period, the narrower the range, and the rarer a loss. Source: annual S&P 500 total returns (Damodaran, NYU Stern, and SPY).
In any given year, the range of outcomes is significant. That’s when investing too aggressively, or for too short a time, can burn investors. But the longer the period, the narrower that spread becomes. Although past performance doesn’t guarantee future results, it can help set our expectations, and give us a guideline for planning purposes.
Another great thing about long-term investing is that the worst outcome gets better and better with time. Over 15-year periods, the S&P 500 has been down only once, and only by a fraction of a percent a year. Over 20-year periods, it has never been down, with a worst average return of 2.4% a year. From there, it only continues to get better.
By having a long-term mindset, not only are we putting our money in a position to work for us, we’re also increasing its chance of success, while reducing risk and volatility. It’s a win across the board.
Your budget allocation
If the idea is to divide our income between now, buffer and Buffett money, the next step is to decide how much goes to each.
Financial planning isn’t one size fits all, because we all have different situations, priorities and goals. People in similar occupations might seem financially similar, but it’s never that simple.
There are benchmarks we can strive towards for contributions, either a specific amount or a percentage of income. But these can vary a lot. Someone who is young and just beginning to invest needs to contribute a lot less to get the same result as someone who starts when they’re older. That’s because the younger person, with presumably the longer time horizon, should earn more from their money working for them.
Starting at 20 instead of 40 cuts the monthly amount needed by almost 80%. Assumes a steady 7% return, compounded monthly. Illustration only. Try your own numbers →
The split between now, buffer and Buffett will depend on your own goals and present financial situation.
Especially in the beginning, building an emergency fund might be a higher priority than long-term investing, because when we make long-term investments, we want to make sure they stay put. Once we have a system in place, we should always expect things to adjust at least a little. Short-term goals come and go, job situations change and need to be re-evaluated, and life always finds ways to influence how we thought things would go. Take a second to think about yourself now compared to five years ago, and imagine that change over the next 60 years. It’ll be a rollercoaster.
You can say I’m biased, and sure, I am. But everyone benefits from working with the right financial planner: someone who works with you to help identify and reach your goals, and someone you can turn to in times of uncertainty or with a question. When it comes to financial planning, there’s no one better qualified to help you.
How we should budget: paying yourself first
Traditional budgeting often leaves us with the scraps of our income to build our future with, and that’s just not enough.
Reverse budgeting is an approach where you identify your goals and what it will take financially to reach them. You prioritize those goals by paying yourself first, essentially treating your future goals as a bill you cannot miss. Then you pay your bills, and the money that’s left over can be spent however you see fit. (It’s one of the key ideas in Making Money Simple.)
This simple reordering of your priorities is such an effective way to manage your finances while always looking out for your future self. You can set up automatic contributions towards your goals that line up with your payday. You can’t spend money you don’t have. By putting it towards your goals instantly, you never have the temptation, or the chance, to spend that money on something else.
Think of it like a pension plan. Everyone loves a pension plan, and if you have one, it’s something you contribute to. Yet people don’t complain that they can’t afford something because they had to contribute to their pension plan from their last paycheque. They know it’s beneficial, and something they should do.
At first it will seem tough, so it’s a good idea to start small. After identifying your goal’s contribution amount, maybe you start at 50% of it, or whatever is comfortable, and build up to 100% over a set amount of time. Over time, studies show that people get used to it, so much so that they forget they’re even contributing, or find they have extra room in their budgets to contribute more.
Sort of like with fitness, today’s workout becomes tomorrow’s warm-up. The small steps we take accumulate over time into a giant leap of progress. We just need to get started.
A better way to budget
To change what those surveys show, we need to collectively get better with our finances. Luckily, the solution isn’t complicated.
We need to rethink what we’re doing, and shift from an ineffective model towards something that’s not only more effective, but easier and less time consuming. It can be tough to envision, but prioritizing our future as early as possible puts the benefit in a position to compound and grow over time. The earlier we start, the more benefit we see.
By prioritizing our future self, and treating it as an obligation like a bill we need to pay, we put ourselves in a position to spend our now money freely. We can’t spend money we don’t have, and by setting up a system to regularly move money from spending to saving, that’s exactly what we’re doing. The best part: once it’s set up, it doesn’t need to take any of our time at all.
Keep doing things your future self will thank you for.
