Wednesday, August 22, 2012

Escape Velocity Aids Wealth Building

Escape velocity is the speed a rocket needs to exceed the gravitational pull of the Earth and launch into space.  It takes a great deal of energy to reach escape velocity.  Once escape velocity is achieved, the amount of energy needed to move further away is greatly reduced.

The concept of escape velocity can also be applied to personal finance.   Once escape velocity is achieved, it is easier to continue in the same direction.  Here are some factors that helped me achieve escape velocity.

  • Wage Income.   I have always been a saver.   In the early years, it never seemed that my savings amounted to much.   The prospects of saving enough for retirement didn't seem possible for the first 16.   For example, even I had been saving $10,000 a year, which I didn't come close to doing, it would have only resulted in $160,000 in principal.

    However, from 16-20 years several things happened that helped achieve escape velocity.  First, during that time, I was promoted twice and my base salary compensation increase significantly.   We chose to keep basically the same lifestyle and save most of the pay increase.  In addition, the company was contributing about 25% of my base salary to my retirement account.  Both elements helped me grow our retirement savings the last third of my career.

  • Interest Rates.  Higher interest rates help also help achieve escape velocity.  At 5% interest rates, $1 million in savings earns $50,000 per year.   At 1% interest rates, the same $1 million only earns $10,000 per year.  At current 0.1% interest rates, $1 million only earns 1,000 per year.

  • Stock Market Returns.  Similar to interest rates, higher stock market returns also help to achieve escape velocity.

  • For many of us, escape velocity has been harder to achieve since in 2007.   Savings growth due to wage income, interest rates and stock market returns has declined significantly and hasn't recovered.

    For more on The Practice of Personal Finance, check back every Wednesday for a new segment.

    This is not financial advice. Please consult a professional advisor.

    Copyright © 2012 Achievement Catalyst, LLC

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