Three Paths to $1 Million

MSN Money lists three paths to $1 million as follows:

Consider these three ways to retire with $1 million:

1. You invest $2,700 per year for 60 years, assuming an annual return of 5%.
2. You invest $14,500 per year for 30 years, assuming an annual return of 5%.
3. You invest $44,500 per year for 15 years, assuming an annual return of 5%.

The first scenario fits more comfortably in most family budgets, requiring a mere $225 a month. The total capital needed to generate that $1 million nest egg is a mere $162,000. For the second scenario, it is $435,000, and it's $667,500 for the third.

In short, compound interest on the proceeds from early investments puts money in your pocket while at the same time saving you money by lowering the outlays into your 401k or IRA. It's a win-win.

My thoughts on this:

• This is right down the middle of what I believe. The underlying advice -- save as early as you can -- is something I agree with 100%.


• As I've noted, saving for as long as possible is the best way to maximize your investment return.


• The numbers above clearly show the power of compound interest, something I've discussed again and again and again and again.


• This is what I've done in growing my net worth -- saving as much as I can for as long as I can. I don't have 60 years to save (even if I had started at 20, I wouldn't be done until I was 80, and I'd like to be done and retired faster than that) :-), and am kind of a combined version of the last two options. I've been saving for 20+ years now and have been saving well over $14.5k per year, so I'm doing fine.


• Anyone noticed that they used 5% in their calculations above? It used to be that we used 10% and moved it to 8% to be conservative. Now with the economy the way it is, we're using 5% -- and that might be too aggressive. Ugh!!

Any thoughts to add? I'm sure many of you have used time and saving to accumulate high net worths. Want to tell us about it?

Comments

[Apex]

The nominal numbers are accurate but it's worth noting that because they are nominal the numbers all appear larger and more impressive than they are because if they were adjusted for inflation they would be much smaller.

If you assume inflation runs at 3% then a 5% return only gives you a real return of 2%. Inflation as measured by the CPI is currently less than 3% but there are certainly many people who think the current situation will eventually cause inflation to sky rocket.

If you were to save for 15 years and accumulate 1 million dollars it would probably buy 2/3 of what it would before you started. If you did so for 30 years it would probably buy 1/3 of what it would when you started. If you did so for 60 years it would probably buy about 1/10 of what it did when you started.

This is a tricky thing to take into consideration but people have to remember that you can't really save for a goal number based on the dollars you think you would need if you retired today. In 1951 a brand new full sized car cost less than $2000. A comparable car today would be $30,000.

So for someone who is 30 looking at the 30 year plan, you need to realized that if you save for 1 million dollars, by 2041 when you would retire it would be worth about $350,000. Which doesn't sound that secure anymore does it?

You need to save more than you think you do.

[Matt]

The examples are somewhat unrealistic. If you were to retire at 65 who at the age of 5 can generate income of $255 a month to save. The 30 year example is good yet unrealistic also in becasue it proves that the limit of 401K of $15k a year is what you would minimally need for a million, but who in there 20ies is willing to put $15k a year away if they have college debt, car payments and a low starting out wage. And yes starting to save for retirement at 40 would require that.

To acheive the million mark in more realistic terms is you need to save as early as you can (like FMF states) but continue to increase your savings rate each year.

An example would be every year I got a raise I raised my 401k contribution by either 1% or 2% each year until I was maxing out at the $15k mark. Now I need to start saving more outside my retirement funds (401k and roth). I know this will get me to the goal but my goal is to ever increase my savings each year to make up for any lack of savings from the past and not being able to fully utilize compounding of interest.

[Strick]

This is actually a nice comparison if you consider the 5% to be the "real" return. I usually ignore these comparisons b/c they usually use 8-10, which i have to think of as actual return, which then makes it hard to compare ($1M in 60 years may be my annual spending).

[Sunil from The Extra Money Blog]

love the 5% assumption - someone is finally recognizing reality, albeit that itself is likely overstating it! unrealistic examples, but the message is well intended and taken

[Ché]

'Conventional wisdom' trumpeted in financial blogs typically overlooks the strategy of earning a high income and instead promotes "investing" in financial products.

For example, I'm earning $300,000 a year (self-employed), saving $150,000 a year (i.e., a million buck in seven years) and not risking "investing" hard-earned dollars in something that is basically gambling, i.e., the highly volatile stock market.

If you want a conventional outcome, follow conventional wisdom.

[FMF]

Che --

If you read what I write (and check the links I've put in this piece) you'll see that I'm doing just what you're suggesting.

[Luis]

@Che If you earn a high income you stand to benefit in a fruitful retirement w/o the need to invest as long as you maintain that low income-to-spending ratio as you mention. Not everyone can have a high income job either so this strategy is for the rest of us!

[Leigh]

Agreed! This is exactly why I'm maxing out my retirement accounts now (also that you don't get the room back later) in my twenties before I even think about having kids. I also find it to be a lot of fun to watch the value of my investments go up so significantly each year. I'm investing somewhere between $14,500 per year and $44,500 per year, so my back-of-envelope calculation is about 20 years until I don't need to work at all. (And that's without a partner sharing the bills/investing.)

[Old Limey]

We bought our first home, brand new, in 1963, at age 29 and in the heart of Silicon Valley for $26,950, now 48 years later it is listed at zillow.com for $726,500 which is an inflation rate of a little over 7%.

In 1960, at age 26, we rented a brand new duplex for $125/month, we could have had a smaller one for $100/month.

My starting salary as an associate engineer in 1960 was $173/week. My ending salary in 1992, at age 58 as a staff engineer was $1,345/week.

It's numbers like this that make it difficult for young people in their twenties to get a handle on what a dollar will buy when they are ready to retire. My sense is that $1M isn't going to feel like a huge amount of money 35-40 years from now.

It took us 32 years from 1960-1992 to accumulate $320K mostly in a company 401K with few investment options. After retiring in '92 we had $1M by 1998 thanks to a good market and $3M by 2000 but that required a once in a lifetime event like the dot.com bubble. You can't rely on events like that.

If inflation does return in earnest then interest rates will increase. Right now at age 77 my approach since late 2007 has been to buy muni and corporate bonds in the secondary market, at or below par and yielding close to 5%, ladder them out with maturities as far out as 2030+ and hold them until they mature at which time I reinvest the money. We will be saving until our last day on earth, not because we need to but because our constantly growing income far exceeds our living expenses. It sure beats the alternative which is running out of money which seems to be rather prevalent right now.

[Apex]

@Leigh,

If you are in your 20s and plan to retire in 20 years I hope you plan to have a lot more than a million dollars. 1 million now will probably be worth 500K in 20 years at best and with the constant march of inflation you will need that money to give you greater and greater income each year. You will also have to make that money last you for another 40+ years and deal with costs in things such as health care which may still be outstripping inflation rates. Unless you have run some very detailed numbers, whatever number you think you need is probably too low, far too low.

[Leigh]

@Apex,

At this point, it's a stretch goal. There are way too many factors to consider to have a definite answer at my age. I'm on track to save/invest almost 70% of my net income this year and that percentage should only go up as my income goes up. My dad has been saying for the last ten years that he plans on retiring at some point in the following ten years.

I think in a few more years, say at age 26 or 27, I'll start trying to run the numbers, but at this point, saving as much as I can is really all I can do and I'm doing that. I'm maxing out my 401(k) and my Roth IRA and investing in taxable accounts, though I doubt I will be eligible for a full Roth IRA contribution again after this year.

[svr]

Old Limey,
It would be difficult to just rely on 1 source of income these days and succeed in retiring well. I read every one of the comments you have posted here on FMF and I can tell, most of the peoples' retirement would not be anywhere near what you have earned/enjoyed.
I come from Asian Background, my ways of living are considered ultra frugal in America(no Cable, Packing lunch, not eating out, average age of the cars in my household is 12 years). There is always a nagging feeling that I am still not saving enough.

[Troy]

This post sounds great. But it is really kind of silly when dug into a bit.

If you take todays numbers, options 2 and three especially are out of range for the average person. The average household can't save 3% of their income (Avg about $50K in 2011), much less the 30% (option 2) or 90% (option 3) that is shown here. So that leaves option one as the only realistic option most people.

But it is 60 years. Starting at 20, stopping at 80. That's a long race, man. To illustrate, imagine if age 80 was todays number and the $1M actually meant something, as it still does today (because if you count saving in todays $225 dollars then you must discout the value of $1M 60 years in the future).

This 80 year old in 2011 would have had to have started investing 60 years ago, in 1951, at age 20, with $2700 per year or $225 per month. Of course the median family income in 1951 according to the census bureau was $3700 (and he likely wasn't a family at age 20, however). SO a 20 year old, right at the beginning of the accumulation stage is supposed to save 73% of his income in year one to get on the path to a million by his 80th birthday.

Right.

[Old Limey]

@svr
You profess to be "ultra frugal" and I believe you.
I am just "frugal" and in fact my wife tells me that I have become progressively more frugal in recent years. I look for bargains in everything I buy and get a small thrill, for example, when I can buy a favorite brand of shirt, in a particular fabric that I like, as new, on eBay, for $10 or $12 when it retails for $140.

I became frugal early in life as a child in England during WWII, in fact most of the nation were that way because of the rationing of everything - food, clothing, candy, gasoline - you name it. We are frequently apalled at the amount of uneaten food that so many native born people leave on the table in restaurants - obviously they don't attach much value to it because they never experienced rationing.

I have cable of course, and Netflix, and our cell phone is kept in the car in case of emergencies and costs me $15 (60 minutes) for 3 months and what I don't use keeps accumulating.

I also refuse to pay the ridiculous prices that most restaurants charge for a bottle of wine and we take our own (that costs us $1.98/bottle by the case) and pay between $7 and $10 max. for a corkage charge.

My wife likes to buy her various greeting cards at the Dollar-Tree store rather than paying Hallmark's ridiculous prices.

It baffles me that so many people buy printer cartridges in stores for $20 each and up, whereas I can buy a complete set of 6 for my Epson printer (non-wireless and non all-in-one) on eBay for $9 including shipping - and they work beautifully.

We have two cars, purchased used, one is 20 years old - 86K, the other is 13 years old - 64K and they are both in pristine condition.

Keep up your good saving habits. The Asians in Silicon Valley are setting a great example to everyone. There is one school district that has a high preponderance of Asians, it is always ranked #1 or #2 in our county test scores and commands home prices about 10% higher than the surrounding districts.

[Mike Hunt]

I was able to hit $1M by age 34 by having a high income and big percentage savings rate.

Once you get to a good number the challenge is to maintain it and live of the dividends, especially if you decide to retire or semi-retire, thereby losing most or all of the income. Using rental property is a good plan, and Apex has detailed this out very nicely.

Living off bond interest for a long period of time usually is not good enough, as the bond rates only adjust and cover for inflation...

-Mike

[Carol]

In your first calculation, 60 years of full time work is unrealistic. A diversion of assets such as cash, Roth IRAs, 401k(403b/257),cash, and annuities, a paid up simple home, and kids out on their own, is a better, more realistic and viable plan. And, yes, you can say "no more" to your adult children and limit the dollar amount that you are willing and able to pay for higher education.

[Old Limey]

Mike:
You are right about the inflation effect upon bond interest rates. In my case I currently have enough bonds to provide over 4 times my final salary when I retired plus I buy another $250K of bonds each year. In addition we have two pensions and two SS checks.
Our bond ladder also stretches from 2012 to 2038 at which time I would be 104 so it might be a problem for the next generation but not for us.

[Tony]

@Old Limey
Why would you have bonds maturing in 2038 when we are in a generationally low interest rate environment. Once interest rates start to go up you'll get hammered in the price of those bonds unless you intend to keep them until they mature. Keep those maturities in the 3-5 year range.