Wednesday, May 10, 2017

Becoming a Millionaire

I recently saw a tweet with a chart showing how much money you need to save each day to become a millionaire at age 65. This was one of those motivational things designed to get young people to start saving. For just two bucks a day, supposedly a 20-year old could become a millionaire in 45 years. I applaud the part of this that tries to get millennials to save money, but two bucks a day won’t make anyone a millionaire.

The implicit assumption in the chart was that we can get a 12% annual return from investments. This is just a dream. With a balanced portfolio and slightly lower than average investment fees, the typical investor could reasonably hope for a 5% annual return.

But this is ignoring inflation. In 45 years, cash might have only one-quarter of its current spending power. When people imagine becoming millionaires, do they really mean to have only the spending power of a quarter million dollars today?

To become a millionaire in today’s dollars, we need to focus on real returns, which are investment returns after subtracting out inflation. Typical investors could hope to get a 2% annual real return. We should also plan to have the amount we save increase by inflation each year.

The following table shows how return assumptions can make a big difference in how much you need to save.


Table: Daily Savings to Become a Millionaire by Age 65




Age 12% Return 5% Return 2% Real Return
20 $1.91 $16.74 $37.73
25 $3.37 $22.13 $44.91
30 $5.99 $29.60 $54.26
35 $10.72 $40.24 $66.87
40 $19.41 $56.02 $84.69
45 $35.92 $80.86 $111.65
50 $69.42 $123.90 $156.87
55 $147.46 $212.56 $247.75

As we can see, the daily savings needed by a 20-year old change radically when we change the return assumptions. Don’t be too discouraged by these numbers, though. You’ll likely get raises during your working life that exceed inflation. So, your capacity to save will likely increase with time.

The important thing is to get into the saving habit now even if the amounts are small. This will give you a head start in building greater savings when you’re older. Those who build too much debt may find they’ll run out of time to dig out of debt and build the savings they’ll need when they’re older.

4 comments:

  1. 12% returns? In the bad old 90's we might have got that 1 or 2 years, but not these days. Of course in the 80's we could buy CSB's that paid 19% too! Ah the good ol' daze of money...

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    1. @Alan: Of course, back when CSBs paid 19%, inflation was high. Real returns for fixed income used to be higher, but not by nearly as much as it seems.

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  2. Well done! I find that converting everything to "today's dollars" is the only way to get meaningful numbers...especially when comparing numbers over time. This is one of the better explanations that I have seen.

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    1. @Garth: Glad you liked it. I agree that thinking in constant dollars is important.

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