A while ago I came across this quote from Warren Buffett, which turned on this bright lightbulb in my head. This is despite the fact that I have spent over twelve years studying the topic of wealth creation. But the way in which Buffett addresses wealth creation in his quote really got me to look at the topic in a new way. I don't want to keep you in the dark any longer and will now share the words of the famous investor:
“I don't want to afford such a car, because it will cost me millions in the future.”
– Warren Buffet, star investor and multimillionaire
What does Buffett mean when he's saying that a car will cost him millions of dollars in the future? In order to understand this, it's helpful to understand the background to this quote. According to the story, Buffett was out with a friend in order to help him buy a car, and was looking at different models. Among them were of course some luxury cars which cost tens of thousands of dollars. Buffett didn't want to buy such an expensive car, and that's how the quote came to be.
In order to understand the true weight of his words, it's also important to think about how the most famous investor on earth thinks about wealth creation. Buffett is not only famous for being one of the richest people on earth; he's also famous for his extremely frugal lifestyle. I write “extremely frugal,” because for a multimillionaire, he really is. But for Buffett it's not about saving 50 cents today and maybe tomorrow saving a dollar. For him, it's more about what those 50 cents will be worth in the future. It's about how many 50 cents he can save in a lifetime and invest, and what could become of those 50 cents.
In order to make this more comprehensible, I want to present a small example that fits with the quote. To be more specific: I want to pit the Germans' favourite child, the car, against the share index S&P 500 for a comparison of returns. In this comparison, we can be assured that Buffett can definitely afford a luxury car. Let's assume that such a car can very well cost 80,000 dollars. Now Buffett has to make a choice. Does he buy the car for 80,000 dollars, or does he invest that through an ETF (Exchange Traded Fund) in the S&P-500-index? I want to also point out that everything takes its time.
There is a time when you start building up wealth, and there is a time where you can enjoy it. I, like most people, enjoy nice and expensive things. But at the same time, I know that investments and consumption must be in a healthy balance if I want to build wealth. In order to make a decision within the context of Buffett's words, we can consult the statistical data of the S&P 500.
Why People Are Millionaires
Since being introduced in 1950, the S&P 500 has an average annual return of about eight percent. Eight percent is not a groundbreaking return. But the benefit of such a “low” return is that the chances are very good that they will continue to stay at the same level in the future. Global economic growth, inflation, and increased productivity through digitalisation will ensure this. So if Buffett were to invest 80,000 dollars through an EFT in the S&P-500-index, keep it there for 40 years, and achieve an average annual return of eight percent on his investment, then he would, at the end of those 40 years, have a total of 1,737,962 dollars to his name. And that's what Buffett means when he says that a car would cost him millions of dollars, therefore reminding us of the power of compound interest. And we haven't even calculated the car's loss of value, its insurance, petrol prices, and the maintenance and repair costs. So we'd surely end up with an amount of over two million dollars that we would have lost within the course of 40 years.
Now you may surely ask: Why do I need all this money if I can't even buy myself a car for 80,000 dollars? Well, first you should have amassed a wealth of two million dollars. And I say that without any irony. Because as soon as you've been able to call the money that you amassed through hard work and smart investment choices your own, you'll realise that this question isn't relevant anymore because you've now developed new habits around your money. Rich people became rich because they were cautious about spending money on things that quickly lost their values, such as cars. On the other hand, they're very returns-focused and invest in things that build wealth, such as having an ownership fraction, owning real estate, or their own business. If you want to continue reading about this subject, I can recommend the books by Dr. Thomas J. Stanley, including his bestseller “The Millionaire Next Door.” Stanley interviewed millionaires and multimillionaires in the USA and was surprised to realise that a large number of millionaires don't live a luxurious and expensive lifestyle. He found out that millionaires dress like normal people and drive used cars, which already have used up a large part of their value and are therefore an acceptable purchase. At the same time, these people have internalised that they just need to give the compound interest effect enough time in order to over-proportionally benefit in the future from an investment that was made today. Ultimately, for them it's about the opportunities that a million-million-dollar fortune gives them, as well as the peace of mind of knowing that they could afford an 80,000 dollar car if they ever really wanted it. Because once in a while, everyone will treat themselves to something “unreasonable.”
About the Author:
Georg Redekop is managing partner of Redekop & Partner KG and specialist author for the magazines "Börse Online" and "€uro am Sonntag".