The book the Automatic Millionaire is an excellent read that I recommend to people all the time. It isn’t a get-rich-quick scheme (which I assumed when I first saw the title). Instead, it focuses on doing smart things – and doing them automatically. One of the specific important points is to automate your investing. This is exactly what I already wrote about explaining DCA (dollar-cost-averaging) and it really is the best way to invest. Read that previous post for details if you don’t already know why it’s so great.
Okay, so let’s say you understand DCA but are curious specifically about the “millionaire” part of things. Well, I was curious too, so I did some back-testing. Back-testing is using a tool that will take a scenario (like DCA) and use the actual real-life results from the past to show what would have happened from those actions.
How much invested monthly reached $1,000,000 by retirement?
I was curious about the amount of money needed to be invested each and every month over an extended period of time to reach one million dollars in an investment account.
To keep things simple I decided to assume an investment that tracked the S&P 500 (an index that includes 500 of the largest public companies in the US).
For a timeline, I decided to use 40 years. Why? Well, my personal “full retirement age” (per the social security administration) is 67. It’s common for people to retire in their early 60s (though I’m a big fan of even earlier retirement!).
Assuming someone is still attending some sort of education until around 22 years old, they’ll start making their career salary somewhere between 22 and 27. Hopefully sooner rather than later, but I know that I personally changed careers and had to “start over” after a couple of years, so I know it happens.
So if reasonable career income starts around 25 (plus or minus a few years) and retirement is going to happen around 65 (plus or minus a few years) that gives a forty-year timeline to build up retirement “savings” (investments).
Had to play with some numbers
I’m not aware of a tool that does this all for you automatically, so I had to use trial-and-error with numbers to find the real answer. But with a little work, I found the answer!
If you started 40 years ago and invested every single month into an index fund tracking the S&P 500: to reach $1,000,000 today you would have had to invest $315 per month. Over this specific time period that would have provided you today with an investment balance of $1,006,108.73. Not too shabby. :) Add that money to your social security income and you can enjoy a nice retirement!
Isn’t that a lot of money?
It’s hard to free up $315 every single month to invest though, right? No, not really.
First off, if you’re doing the bulk of your investing through a 401k or IRA, the real cost of the $315 is only about $236 (assuming a 25% tax bracket). Since you defer taxes on those types of investments, the money that would have gone to the government in taxes can actually go into your investment account. $315 per month is $3,780 per year, so that’s well below the contribution limits for those types of accounts.
Secondly, think of it this way, that $236 is only $7.87 per day. Do you smoke, or drink Starbucks coffee, or grab a quick-lunch “out” most days? Knocking just one of those things out almost covers the entire amount needed to retire a millionaire. I hope you enjoy that daily latte!
Some other things to consider: the average US car payment is $479 per month. The average cable TV bill is $103/month; an average cell phone bill, for two people, is $140/month; and the average American family spends at least $236 each month dining outside of the home.
I’m not saying you need to knock out these things – though it certainly might be worth considering. What I am saying that, in context, $236 isn’t that much money to most families. You’re already spending at least that much on items with very short enjoyment periods. Isn’t it worth spending that much to retire with a million bucks?
What investment returns does this assume?
Again, to be clear, I’m not making up my own investment returns – this exercise uses the actual returns from the S&P 500 index over the last 40 years. What was the average return for that index over that period? It was just under 8%.
I personally think moving forward we’ll get back closer to the lifetime average of the stock market of around 10%.
Why? Because during this most recent 40 year period we had two huge market corrections – the “dot-com bust” around 2000 and the burst of the housing bubble around 2008. It’s very unusual – looking at the market historically – for two large corrections like that so close together.
But, corrections happen, so expect it and be okay with it – that is just part of being an investor. [Read more about the volatility concern here.] Remember that if you are buying consistently every single month, you are also buying at a discount during any downturns in the market.
In fact, per the way DCA works, during a downturn in the market, you are buying more shares at the lower price than you would at the higher price – so your average cost is lower than people who don’t invest consistently would pay.
Could you still hit $1 million investing less?
Yes, actually there is a high likelihood that you could have still hit a million dollars while investing less each month. As mentioned above, this scenario involves investing in a single index fund that tracks the S&P 500. If you did something closer to what Dave Ramsey recommends and split your investments across four types of funds – Growth, Growth and Income, Aggressive Growth, and International – your returns likely would have been even better. The reason is that for the same time period, aggressive growth and international funds had higher returns, so those holdings would help bring the total return of your investment portfolio higher, meaning less money would be needed to be invested each month to reach the $1 million goal.
Please note that if you are like most investors and have a portion of your investments in bondsthen your personal rate of return would actually be lower. So you would have had to invest more money every month to reach the $1 million goal.
Of course, your market fluctuations would have been a bit smoother than someone who invested 100% in stocks too. Just understand that the cost for that peace of mind can really add up over time. In fact, the bond portion of any portfolio can easily lag the performance of stocks by 5% or more each year.
If you have a low tolerance for risk then maybe some allocation of bonds makes sense for you, but just understand that the lower “risk” (volatility really) also means lower “rewards” (investment returns).
Are you ready to be an automatic millionaire?
If you are still in your 20s (or know someone in their 20s – please share this with them) – why not get started now and retire a millionaire?
A bit further along in life? Well, it isn’t too late! Yes, you will need to invest more each month to play catch up, but for many people, it is still an achievable goal. Knock out a car payment, student loan, and/or some additional non-essential spending, and you will likely have plenty to invest in a comfortable retirement. Just be purposeful because most people who free up money wind up spending it on something else, keeping themselves behind schedule on retirement. Make a plan and stick to it. When you are retired and wealthy you’ll be thankful you did!
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The calculator is a great tool, passing this on to my daughters.
Great post, Brad. People don’t realize how easy it is to reach millionaire status. Or to put aside $315 a month. Before our financial transformation, we were wasting $275 a month on eating out alone. Just a few budget cuts will round up $300 for most people.
Thanks! Yeah, more people need to understand how small wasted spending quite likely costs them a million dollars over their lifetime. Quite a few of the people we work with have no idea what they spend on eating out. And once they do understand it, they WISH it was only $275/month. :) Quite a few are hitting the $1,000 mark without even knowing it.
Great stuff! It’s so interesting to play with savings rates and see what effect compounding returns will have on them over time. One tactic that I plan to use on my kids is to encourage them to start an IRA when they get their first part-time job. Could you imagine how much money you’d have today if you had started saving at age 16? Run those numbers and you’ll be blown away!
Thanks MMD! Yeah, the power of “time” combined with investing has huge impact. The earlier you can get started – and stick with it – the more wealth-building potential you have. Everyone needs to understand this.
Great post, Brad. The Automatic Millionaire is one of my favs. It’s so important that every college grad know they have the potential of being a millionaire – if only they take the steps to make it happen! Forwarding this to my 20 y.o. :)
Loved the post. I agree 100% it’s about DOING it and making the concessions to do so. $315/month is not a lot to become a millionaire. Having the discipline and fortitude to do is is another story. I think the issues lie in that a lot of people mistake needs VS wants, get caught up in keeping up with the Jones’s and marketing to the consumer is getting better and more sophisticated. However, if you set your mind to it, you can literally do ANYTHING! I took Dave’s financial peace and it changed my life! No more debt and saving a large portion for retirement. Automatic savings works! You just have to COMMIT to it.
“No more debt and saving a large portion for retirement.”
AWESOME job! Sounds like you’re on a great path to financial independence!
I’ve been using Betterment and it is a great hands off approach to investing! Hard not to make money in this bull market!
Indeed! Thanks for stopping by MMG!