It’s part of the American Dream, to be “Rich“, but what does this mean? People associate millionaires with being rich, but what exactly is a millionaire? For practical purposes, a millionaire has a household Net Worth of $1,000,000 or greater. According to a recent article on Kiplinger.com, in 2019 6.71% of households could claim millionaire status. Is that enough to achieve Financial Independence and fund (an early) retirement?
| TL; DR: Probably not, but it’s a good start! |
So a fairly small percentage of households have $1M in net worth, but how do families achieve this? Some inherit it, some win the lottery, some have large salaries such as professional athletes, movie stars, or CEOs. Is it possible when earning a wage close to the median income ($68,703 in 2019 according to an article at census.gov)? Let’s walk through an example, but it is possible with two powerful forces: time and compound interest.
Compound interest is the eighth wonder of the world. He who understands it earns it… he who doesn’t… pays it.
Einstein
When I was growing up in the 1980s, I absorbed the financial, wealth-building, and retirement advice from my mother with the goal of becoming financially independent and retiring “early”. We talked about the power of compound interest and the importance of starting early. She explained the Rule of 72, as a tool to show the mechanics. The Rule of 72 is an approximation for the amount of time it will take for an investment to double, based on a rate of return as a percentage as shown in the table below from investopedia.com. As you can see, it is not as accurate with very low or very high rates of return, but it does give us a decent estimate.
Conventional wisdom says to try to save 10% of your income as a good starting point. To illustrate the power of compound interest, let’s take 10% of the 2019 median income as an annual savings goal. This means saving $572.50/month. In this simplified use-case, a household saves $6,870 (10% of the 2019 median income) per year from age 20 until age 30, or a total of $68,700. According to the Rule of 72, if they earn 7% on the $68,700 they saved over those 10 years, savings would double approximately every 10 years like this:
- Scenario 1: Save $6,870/year from age 20 – 30, investments earn 7% annually
- Savings at age 30: $68,700
- Age 40 => $137,400
- Age 50 => $274,800
- Age 60 => $549,600
- Age 70 => $1,099,200
This hypothetical family has reached millionaire status at age 70! Waiting until 70 to tap the funds may be unlikely, but for illustrative purposes it shows that a household with a “median” income that saves 10% could hit the $1M level in theory. Keep in mind, in this example, they only saved from ages 20 – 30, then stopped saving.
To show the power of starting early, compare this to another hypothetical household that earns double the median income and saves twice as much for 10 years ($13,740 per year). In this example, they don’t start saving until age 30. This household achieves the same results, but they need to allocate two times as much in savings to catch up ($137,400 vs $68,700).
- Scenario 2: Save $13,740/year from age 30 – 40, investments earn 7% annually
- Savings at age 40: $137,400
- Age 50 => $274,800
- Age 60 => $549,600
- Age 70 => $1,099,200
So this is the theory, and being a nerd 🤓, I would run numbers in my head for different scenarios. What if I could earn more than 7% a year? My mother and investopedia also told me the long term rate of return in the S&P 500 is roughly 10% since inception. This does not mean that the stock market goes up 10%/year. It may go up 20% one year, then down 30% the next year, but over longer periods of time, the overall rate of return averages about 10%. Index fund investing can be a low cost/low maintenance way to achieve great returns over the long haul. In my example above, achieving 10% returns would change the outcome like this:
- Scenario 3: Save $6,870/year from age 20 – 30, investments earn 10% annually
- Savings at age 30: $68,700
- Age 37 => $137,400
- Age 44 => $274,800
- Age 51 => $549,600
- Age 58 => $1,099,200
- Age 65 => $2,198,400
Wow, that’s quite a difference, now they hit multimillionaire status! To extrapolate even further, what if we are able to save more aggressively and what if we don’t stop investing? Remember these simplified examples assumed that we only contribute for a 10 year period. The calculations are more complex, but I felt that I could achieve the following: become a multimillionaire, maybe retire “early”. I started to daydream about other ways to improve my nest egg.
As I started my professional career and started learning more about investing, I was shocked that everyone wasn’t following this recipe to have adequate savings. Over time, I started to see the practical “real-world” results of all the theory come to fruition, but I also found that there are a lot of details and other things to consider. Investment strategies, allocations, tax implications, analyzing net worth (to see “where we are”), budgeting (to see “how we’re doing”), etc. I started with a straight-forward S&P 500 Index fund strategy, but my curiosity led me to evolve to “aggressive growth” with individual stocks in my younger days. We went through some painful times like the dotcom bust, then the Great Recession, and of course the debacle of 2020 and COVID-19, but we stayed the course.
Over time I switched to a Dividend Growth Investment strategy (DGI), and started to plan for the income replacement needed if I really was able to achieve “early” retirement. Now that I’m in my late 40s, I’ve maintained some of elements of my former strategies, but also incorporate income focused investing to really supercharge my passive cash flow, in both tax sheltered and non tax-sheltered accounts.
Sounds simple: save a good percentage, maybe 10% as a good baseline to start, and invest early and stick with it. Clearly it is not and a lot of folks don’t save enough or even any at all! According to a Gallup Poll, as of June 2020 only about 55% of people invest in the stock market. Looking at average retirement savings at smartasset.com, there is clearly a gap for most people. I still think the concepts are simple, but putting it into practice takes commitment, diligence, and some luck for good measure. We need to take a holistic approach to our personal wealth and finances and consider all angles: maximize income, minimize or at least manage expenses, balance risk and asset allocation based on where we are in our life arc. These details are always changing, so it is never boring, there are always nuances and new information to consider.
A few years ago I calculated our net worth and discovered that we had passed the $1M barrier. More recently we eclipsed the $2M barrier. In both cases I was expecting confetti and balloons, but nothing happened. A recent article on cnbc.com shows that in 2019 you need $2.3M to be considered “rich” because of inflation and other factors. We have achieved this level as of Feb 2021, but we definitely don’t feel “rich” yet, because we haven’t achieved our goals.
Our Goal for financial independence and retirement is to have enough income to meet our post-retirement budget, after I leave my day job. It’s not really based on a concrete number like $2.3M. Some people, such as those in the FIRE movement, may be very aggressive with their saving, cutting expenses, and eliminating debt, so they may be “rich” with $1M or even less. We choose to take a different approach and indulge in some things that we enjoy now: vacations, cars, and also things we think are important: like private school for our children. We have many options on how to achieve our Goal, and the plan will continually evolve. It will include passive income from non tax-sheltered accounts, side hustles, and accessing tax-sheltered accounts if necessary (without paying any penalties).
Subscribe to get email updates when we post new content and please discuss further in the comments below or let me know if you have any questions or other feedback.
| Disclaimer: I am not a financial planner and content on this site is meant to provide food for thought, not professional advice. I share my experiences to show what worked so far and what didn’t, YMMV. Please consult your financial advisor or tax professional as needed. |
