The First Million is the Hardest Million to Make

The following is an excerpt from Your Financial Playbook: A Guide to Navigating the World of Personal Finance.

Why does the 1st million seem so difficult to make? It’s the principle of compound interest that makes the 1st million the hardest million that you will ever earn. Here are a few examples.

• If you started with $100,000 and would like it to grow to $1,000,000 than you would need a 900% return on your money. ($100,000 + $900,000) = $1,000,000
• If you started with $10,000 and would like it to grow to $1,000,000 than you would need a 9,900% return on your money. ($10,000 + $990,000) = $1,000,000
• If you started with $1,000 and would like it to grow to $1,000,000 than you would need a 99,900% return on your money. ($1,000 + $999,000) = $1,000,000
• If you started with $100 and would like it to grow to $1,000,000 than you would need a 999,900% return on your money. ($100 + $999,900) = $1,000,000

As you can see it takes astronomical returns on your money to make $100, $1,000, $10,000 and $100,000 grow to a million dollars. Suppose that you already had $1,000,000 dollars and would like to turn it into $2,000,000 dollars. What type of return would you need to achieve that?

($1,000,000 x 100% = $1,000,000) You would need a 100 percent return in order to turn $1,000,000 into $2,000,000 dollars. A 100% return seems paltry compared to the returns listed above. So, what does all of this illustrate? This explains why it is easier for a millionaire to become a multimillionaire than for an individual with a few thousand dollars to become a millionaire. Remember it’s not impossible to become a millionaire just remember two simple rules.

1. You need to continually increase the amount that you are investing. The greater the amount that you are willing to invest can help lower the return needed to achieve your goals. Saving more money today means that you don’t have to chase high returns tomorrow. It’s better to be in a position where you can accept a 10% return on your money rather than chasing a 1,000% return.

2. You need to give yourself ample time to reach your financial goal. The principle of compound interest works best for you over longer time periods. All things being equal an individual that invests for 20 years has the potential for a greater return than someone who invests for 5 years.

Ha! Just like I said in Two Simple Equations that Lead to Financial Success.

Comments

[Old Limey]

The first million is absolutely the hardest to achieve because of the two rules I believe in.

Rule #1 --- Don't Lose Money - i.e. Avoid having a losing year.
Rule #2 --- Understand the power of compounding.

The other technique that works well is Dollar Cost Averaging by making frequent additional investments, as in a 401K.

I have trading authorization on my 46 year old son's 401K and even though he has a paltry number of available funds to choose from in a Fidelity 401K it has done pretty well and never had a losing year.
When I took it over on 11/26/99 it had a value of . $7,103.45
As of close of market 06/28/10 it has a value of $206,337.46
He has made the maximum contribution allowed for many years. His company cancelled the employer match when the recession started but they have recently reinstated it.
His 401K has been 100% in Pimco's Total Return Bond fund since November 2007.

[Mike Hunt]

The first million comes from high savings rate and maximizing your incoming by managing your career, a topic that has been covered at length at FMF.

-Mike

[Doug Warshauer]

It's easiest to think about this if you know how to calculate how long it will be for your money to double by using the Rule of 72. Take the rate of return you expect on your investment and divide that number into 72. The answer equals the number of years it will take for your money to double.

For example, if you expect to earn 10% on your investment, your money will double in 7.2 years. It will have doubled twice in 14.4 years and three times in 21.6 years. Doubling three times gives you eight times the amount you started with (2x2x2=8). So if you have $100,000 today, at a 10% annual return you will have $800,000 in 21.6 years.

This simple rule of thumb makes it easy to forecast how much money you'll have in the future at different rates of return.

[Paul]

Old Limey, you are a skilled investor. Ever think of making financial advising a part time post retirement career?

[Old Limey]

Paul:
Definitely not for several reasons.
1) You need to be licensed to manage other people's money.
2) You would probably need to start a company - something I checked into once and decided it wasn't for me.
3) You need very expensive liability insurance in case you get sued.
4) I don't need the hassle of people calling me up and second guessing what I am doing.
5) I have always had just one style of investing and it changed as I became older and wealthier. At 75 I could not put myself into the position of investing the way someone that is decades away from retiring would probably want to invest. My children are a different story, they never bug me at all, they are very happy that they have never had a losing year, and they know they will be beneficiaries one day to a sizeable estate.
6) I don't need the money.

[Rob]

I'm with Mike Hunt. It is about saving AND your career. Since it is a lot easier to get $! million when you start with $100k, why not start with even more if you can?

[Eric]

Old Limey, are you interested in adopting me then? ;-)

[Meghan]

Looks like you're right. I guess I gotta keep truckin' then...=)