Expert reveals THE most critical thing to building wealth (and it’s not what you think)

Most investors would think two factors have the biggest influence on their ability to reach financial independence: income and investment returns.

But US financial expert and buy-and-hold advocate Brian Feroldi sees it differently.

He cites a famous economic rule to explain.

“In the 1920s, Italian economist Vilfredo Pareto noticed something in his garden,” Feroldi said in his Long-Term Mindset newsletter.

“80% of his peas came from just 20% of his plants.”

He then also noticed the same pattern in his day job.

“80% of the land was owned by just 20% of the people.”

That was the birth of the Pareto Principle. 

“It’s since become a powerful tool that helps to separate ‘signal’ from ‘noise’. By zeroing in on the small — but impactful — inputs, you can gain incredible leverage.”

How the Pareto Principle applies to building wealth

The principle also applies to investing.

And this is where the notion that income and investment returns are the most important variables towards financial independence.

They’re not, according to Feroldi.

“Those two factors are important, but they are more ‘noise’ than ‘signal’.”

He said the most important factor to building wealth, the critical 20%, is one’s savings rate as a proportion of take-home pay.

Sure, a massive income is certainly helpful, but Feroldi says it’s not “a cure-all”.

“Just ask some of the highly-paid celebrities and athletes who [end] up filing for bankruptcy protection — Mike Tyson, Nicholas Cage, Lindsay Lohan.”

And high investment returns also help, but it’s absolutely useless if one’s savings rate is miniscule.

“This is why your savings rate is so important. It’s the small input that can [reliably] predict your ability to become wealthy.”

Feroldi admitted concentrating on saving is not an exciting message. But if you do it well then it will be “hard not to become wealthy” over time.

“Over the long run, you have far more control over it than your salary or investment returns.”

The post Expert reveals THE most critical thing to building wealth (and it’s not what you think) appeared first on The Motley Fool Australia.

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Motley Fool contributor Tony Yoo has no position in any of the stocks mentioned. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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