The bulk of mainstream financial advice is focused on reducing costs, boosting income, saving as much as possible and investing consistently. These are all crucial elements, but at a certain stage of your wealth-building journey, they become less important.
This is because of the way compounding growth works. Wealth grows exponentially, yet most of the impact occurs in the later stages. When you’re just getting started, with little to no capital, progress is relatively slow, modest and sometimes a little frustrating. The gains feel small because compounding hasn’t had time — or scale — to work its magic.
Here’s how to figure out when you will hit that so-called crossover point and how to get there as quickly as possible.
The crossover point for wealth creation occurs when your portfolio growth rate exceeds your annual contributions.
Let’s say you save and invest $1,000 a month starting from zero. If your investments grow at 7% a year, it would take you roughly 10 years to reach about $165,800.
The vast majority of this wealth, $120,000, was contributed by you. Your money, not compounding, is still doing most of the heavy lifting. A 7% return on $165,800 is $11,606, which is still less than your annual contribution of $12,000.
You’ll hit the crossover point in year 11. At that stage, your portfolio will be worth $189,400 and a 7% return will deliver $13,258. The power of compounding is now the key engine driving you forward.
Every year beyond this point, your annual contributions are of diminishing importance. The portfolio begins to carry itself forward. Eventually, perhaps when you reach millionaire status, an annual contribution of $12,000 barely registers, amounting to little more than a rounding error.
If that sounds appealing to you, there are ways to get to that crossover point a little sooner.
Because of the way compounding growth works, a dollar saved today is more powerful than a dollar saved tomorrow. With that in mind, if you can accelerate your pace of saving and investing for a brief period at the beginning of your journey, you could shorten the distance to the crossover point.
Let’s take the previous example.
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You’re investing in an asset that delivers 7% returns per year and your end goal is to reach the crossover point as soon as possible. If you boost your annual savings to $18,000, or $1,500 per month, instead of $12,000, you could accumulate over $57,800 within three years. After this brief period of aggressive savings, you can revert to $12,000 in annual savings and get to $172,684 within six years.
A 7% return on $172,684 is $12,088, which is greater than your annual contribution. In other words, you’ve reached the crossover point in nine years instead of 11.
Simply put, if you can boost your savings rate, tighten your budget or find a side gig to enhance income just for a few years, you could get financial freedom much sooner.
Because savings and contributions play a smaller role after the crossover point, some people are tempted to abandon them altogether.
An offshoot of the online FIRE movement (Financial Independence Retire Early) is what’s known as Coast FIRE. This community focuses on aggressively saving and investing as early as possible to reach the crossover point and then coasting to retirement solely with the power of compounding. In other words, they significantly reduce or stop saving altogether, allowing their nest egg to grow on its own.
Obviously, this strategy slows down progress and delays retirement. Most coasters, according to Empower, continue to work to traditional retirement age (1).
It’s not for everyone. But if you like your job, don’t mind retiring later and don’t enjoy saving money, this could be an ideal strategy for you.
If you’re saving and investing for retirement, the crossover point is a key milestone that lets you know you’re on the right track.
Your monthly or annual contributions may become gradually less important beyond this point, but abandoning them completely comes with some risks.
Put simply, if you stop investing at the crossover point, you leave no room for error. A sudden job loss or unexpected emergencies could force you to draw on your nest egg prematurely, derailing your long-term plans. Meanwhile, losing your savings habit could push your spending beyond your budget and gradually diminish your financial security.
Your portfolio’s growth could also be interrupted by a sudden wave of inflation or a prolonged market downturn. Past performance is never an indication of future returns, and if your long-term compounding growth rate is even 1% lower than your target, you could delay retirement by a few years.
Because of this, the safest approach is to consider the crossover point a key milestone for your psychological well-being and persist with your savings and investment plan as usual.
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Empower (1)
This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
