A few years ago, Richard Russell of the Down Theory Letters wrote an incredibly powerful article titled, “Rich Man, Poor Man.” In the article he wrote how important it was for the average investor (you and me) to have a financial plan utilizing the power of compounding. I’ll share a simple plan with you in this article. Before I do, I want to quote a portion of Rich Man, Poor Man:

“Compounding is the royal road to riches. Compounding is the safe road, the sure road, and fortunately, anybody can do it. To compound successfully you need the following: perseverance in order to keep you firmly on the savings path. You need intelligence in order to understand what you are doing and why. And you need a knowledge of the mathematics tables in order to comprehend the amazing rewards that will come to you if you faithfully follow the compound road. And, of course, you need time, time to allow the power of compounding to work for you. Remember, compounding only works through time.”

Compounding is not about getting rich quickly. It’s about creating a compounding financial plan and sticking with this plan for years. This isn’t as easy as it sounds because we tend to get easily distracted. Richard Russell wrote:

“There are two catches in the compounding process. The first is obvious – compounding may involve sacrifice (you can’t spend it and still save it). Second, compounding is boring – b-o-r-i-n-g. Or I should say it’s boring until (after seven or eight years) the money starts to pour in. Then, believe me, compounding becomes very interesting. In fact, it becomes downright fascinating!”

He is 100% correct.

Imagine if when you were born, your parents created a compounding fund for you and started saving $200 a month. Each month until you turn 18 they contribute $200 a month into this account on your behalf in order to help get you started on your path to a multimillionaire.  At the age of 18, you take over and continue contributing $200 each month. If you continue to make your $200 contribution to your compounding fund and earn 10% over time, you will be rewarded with $7,672,341 around your 60th birthday.

$200 a month turns into $7.6 million in 60 years.

Compounding IS downright fascinating, isn’t it?

If this compounding fund was setup for you and followed for 60 years, you would be guaranteed to be a multimillionaire. What you did for a living wouldn’t matter. Your salary wouldn’t matter. How much you put into your company 401k plan wouldn’t matter. A college degree wouldn’t matter. In fact, you could be a complete wreck financially, living in a van down by the river, and you would still have $7.6 million at 60 IF you followed this plan and continued saving $200 a month allowing the magic of compounding to work silently for you throughout your life.

How hard is it to save $200 a month? Not too hard. The challenge is staying committed to this boring plan for 60 years.

Back to Richard Russell…

“In the investment world the wealthy investor has one major advantage over the little guy, the stock market amateur and the neophyte trader. The advantage that the wealthy investor enjoys is that HE DOESN’T NEED THE MARKETS. I can’t begin to tell you what a difference that makes, both in one’s mental attitude and in the way one actually handles one’s money.

The wealthy investor doesn’t need the markets, because he already has all the income he needs. He has money coming in via bonds, T-bills, money market funds, stocks and real estate. In other words, the wealthy investor never feels pressured to “make money” in the market.

The wealthy investor tends to be an expert on values. When bonds are cheap and bond yields are irresistibly high, he buys bonds. When stocks are on the bargain table and stock yields are attractive, he buys stocks. When real estate is a great value, he buys real estate. When great art or fine jewelry or gold is on the “give away” table, he buys art or diamonds or gold. In other words, the wealthy investor puts his money where the great values are.

And if no outstanding values are available, the wealthy investors waits. He can afford to wait. He has money coming in daily, weekly, monthly. The wealthy investor knows what he is looking for, and he doesn’t mind waiting months or even years for his next investment (they call that patience).

But what about the little guy? This fellow always feels pressured to “make money.” And in return he’s always pressuring the market to “do something” for him. But sadly, the market isn’t interested. When the little guy isn’t buying stocks offering 1% or 2% yields, he’s off to Las Vegas or Atlantic City trying to beat the house at roulette. Or he’s spending 20 bucks a week on lottery tickets, or he’s “investing” in some crackpot scheme that his neighbor told him about (in strictest confidence, of course).

And because the little guy is trying to force the market to do something for him, he’s a guaranteed loser. The little guy doesn’t understand values so he constantly overpays. He doesn’t comprehend the power of compounding, and he doesn’t understand money. He’s never heard the adage, “He who understands interest – earns it. He who doesn’t understand interest – pays it.” The little guy is the typical American, and he’s deeply in debt.

The little guy is in hock up to his ears. As a result, he’s always sweating – sweating to make payments on his house, his refrigerator, his car or his lawn mower. He’s impatient, and he feels perpetually put upon. He tells himself that he has to make money – fast. And he dreams of those “big, juicy mega-bucks.” In the end, the little guy wastes his money in the market, or he loses his money gambling, or he dribbles it away on senseless schemes. In short, this “money-nerd” spends his life dashing up the financial down-escalator.

But here’s the ironic part of it. If, from the beginning, the little guy had adopted a strict policy of never spending more than he made, if he had taken his extra savings and compounded it in intelligent, income-producing securities, then in due time he’d have money coming in daily, weekly, monthly, just like the rich man. The little guy would have become a financial winner, instead of a pathetic loser.”