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.