I came across this article. It states,
The plan calls for young people to put 15 percent of their salary into a savings account — whether it be an IRA, 401(k) or taxable account — starting at 25 years old, he wrote for Business Insider. By spreading that money to three different kinds of funds, over time the money will accumulate and turn a milliennial into a millionaire
Whats everyone's take on it? Can saving/investing 15% of your income starting age 25, likely make you a millionaire?
Yes, quite easily, in fact.
You left a lot of numbers out, so lets start with some assumptions. If you are at the median of middle income families in the US that might mean $70,000/year. 15% of that is an investment of $875 per month.
If you invest that amount monthly (starting at age 25) and assume a 6% return, then you will have a million dollars at approximately 57 years old. 6% is a very conservative number, and as Ben Miller points out, the S&P 500 has historically returned closer to 11%. If you assumed an aggressive 9% return, and continued with that $875/month for 40 years until you turn 65, that becomes $4 million.
Start with a much more conservative $9/hr for $18,720 per year (40 hours * 52 weeks, no overtime). If that person saved 14% of his/her income or about $219 per month from 25 to 65 years old with the same 9%, s/he would still achieve $1 million for retirement.
Is it much harder for a poor person? Certainly, but hopefully these numbers illustrate that it is better to save and invest even a small amount if that's all that can be done.
High income earners have the most to gain if they save and the most to lose if they don't. Let's just assume an even $100,000/year salary and modest 401(k) match of 3%. Even married filing jointly a good portion of that salary is going to be taxed at the 25% rate. If single you'll be hitting the 28% income tax rate.
If you can max out the $18,000 (2017) contribution limit and get an additional $3,000 from an employer match (for a total monthly contribution of $1750) 40 years of contributions would become $8.2 million with the 9% rate of return.
If you withdrew that money at 4% per year you would have a residual income of $300k throughout your retirement.
It depends on how much you save, how much your savings earns each year.
You can model it with a very simple spreadsheet:
Formula view:
You can change this simple model with any other assumptions you wish to make and model. This spreadsheet presumes that you only make $50,000/year, never get a raise, that your savings earns 6% per year and that the market never has a crash like 2008. The article never states the assumptions that the author has made, and therefore we can't honestly determine how truthful the author is.
I recommend the book Engineering Your Retirement as it has more detailed models and goes into more details about what you should expect. I wrote a slightly more detailed post that showed a spreadsheet that is basically what I use at home to track my retirement savings.
Millionaire, Shmillionaire! Let's do this calculation Bruno Mars style (I wanna be a Billionaire...)
If my calculations are correct, in the above scenario, at age 80, you would have more than a billion in the bank, after taxes.
Yes, becoming a millionaire is a reasonable goal. Saving 15% of your income starting at age 25 and investing in the stock market will likely get you there.
The CAGR (Compound Annual Growth Rate) of the S&P 500 over the last 35 years has been about 11%. (That 35 years includes at least two fairly serious crashes.) You may get more or less than that number in the future, but let's guess that you'll average 9%.
Let's say that you begin with nothing invested, and you start investing $100 per week at age 25. (If your annual income is $35,000, that is about 15% of your income.) You decide to invest your money in an S&P 500 index mutual fund.
35 years from now when you are 60 years old, you would be a millionaire ($1.2 Million, actually).
You may earn less than the assumed 9%, depending on how the stock market does. However, if you stick with your 15% investment amount throughout your whole career, you'll most likely end up with more, because your income will probably increase during your career. And you will probably be working past age 60, giving your investments time to earn even more.
The article links to William Bernstein’s plan that he outlined for Business Insider, which says:
Put equal amounts of that 15% into just three different mutual funds:
• A U.S. total stock market index fund
• An international total stock market index fund
• A U.S. total bond market index fund
Over time, the three funds will grow at different rates, so once per year
you'll adjust their amounts so that they're again equal.
That's it.
Modelling this investment strategy
Picking three funds from Google and running some numbers.
MUTF: VTSMX Vanguard Total Stock Market Index
MUTF: VGTSX Vanguard Total International Stock Index Fund Investor Shares
MUTF: VBMFX Vanguard Total Bond Market Index Fund Investor Shares
The international stock index only goes back to April 29th 1996, so a run of 21 years was modelled. Based on 15% of a salary of $550 per month with various annual raises:
annual salary total contributions final investment
rise (%) over 21 years value after 21 years
0 20,790 43,111
1 23,007 46,734
2 25,526 50,791
Broadly speaking, this investment doubles the value of the contributions over two decades.
Note: Rebalancing fees are not included in the simulation.
Below is the code used to run the simulation. If you have Mathematica you can try with different funds.
funds = {"VTSMX", "VGTSX", "VBMFX"};
(* Plotting the fund indices *)
{tsm, ism, tbm} = FinancialData[#, {"April 29, 1996",
DateList[], "Month"}] & /@ funds; DateListPlot[
Transpose[{First /@ #, 100 Last /@ #/#[[1, 2]]}] & /@
{tsm, ism, tbm}, PlotLegends -> funds, PlotLabel ->
"Indices from month-end April 1996 rebased to 100"]
(* Plotting the investment contributions *)
salary = 550;
investment = salary*0.15;
inflation = 2;
nmonths = Length[tsm] - 1;
ny = Quotient[nmonths, 12];
iy = Array[investment/3 (1 + inflation/100)^(# - 1) &, ny];
d = Take[Flatten[ConstantArray[#, 12] & /@ iy], 12 ny];
DateListPlot[Transpose[{Take[First /@ tsm, 12 ny], 3 d}],
PlotLabel -> Row[{"Monthly contributions with ",
inflation, "% inflation - Total = ",
Total[3 d]}], PlotRange -> {Automatic, {0, Automatic}},
PlotMarkers -> {Automatic, 6}, FrameLabel -> {"Time",
Rotate[Style["$", 12], Pi/2]}, ImageSize -> 380]
(* Calculating & plotting the investment values *)
{tsm2, ism2, tbm2} = Take[Ratios@# - 1, 12 ny] & /@
Map[Last, {tsm, ism, tbm}, {2}];
d2 = 0;
ds = {};
eachyear[yr_] := Last /@ Function[series,
AppendTo[ds, Total@Array[(d[[# + 12 (yr - 1)]] +
If[# == 1, d2/3, 0]) Apply[Times,
1 + series[[# + 12 (yr - 1) ;; 12 yr]]] &,
12]]] /@ {tsm2, ism2, tbm2}
vals = Array[(d2 = Total@eachyear[#]) &, ny];
rd = Last /@ Partition[Take[First /@ tsm, {2, 12 ny + 1}], 12];
DateListPlot[Transpose[MapThread[
{{#1, #2[[1]]}, {#1, #2[[2]]}, {#1, #2[[3]]}} &,
{rd, Partition[ds, 3]}]],
PlotMarkers -> {Automatic, 8}, PlotLabel -> Row[{
"Individual fund investment values over ", ny,
" years"}], PlotLegends -> funds, Epilog -> {Red,
Arrowheads[0.06], Arrow[{{{2007, 10, 1}, 12000},
{{2008, 10, 1}, 9000}}]}, FrameLabel -> {"Time",
Rotate[Style["$", 12], Pi/2]}, ImageSize -> 400]
Notice above how the bond index (VBMFX) preserves value during the 2008 crash. This illustrates the rationale for diversifying across different fund types.
DateListPlot[Transpose[{rd, vals}],
PlotMarkers -> {Automatic, 8}, PlotLabel -> Row[{
"Total investment value over time - Final value = ",
Last[vals]}], FrameLabel -> {"Time",
Rotate[Style["$", 12], Pi/2]}, ImageSize -> 400]
I'll offer another answer, using different figures.
Let's assume 6% is the rate of return you can expect. You are age 25, and plan to retire at age 65. If you have $0 and want $1M at retirement, you will need to put away $524.20/month, or $6,290.40/year, which is 15% of $41,936. So $41,936 is what you'd need to make per year in order to get to your target.
You can calculate your own figures with a financial calculator: 480 months as your term (or, adjust this to your time horizon in months), .486755% as your interest (or, take your assumed interest rate + 1 to the 1/12th power and subtract 1 to convert to a monthly interest rate), 0 as your PV, and $1M as your FV; then solve for PMT.
I see a lot of answers calculcating with incomes that are much higher than yours, here is something for your situation:
If you would keep your current income for the rest of your life, here is approximately how things would turn out after 40 years:
All interest is calculated relative to the amount in your portfolio. Therefore, lets start with 1 dollar for 40 years:
With your current income, 15% would be 82.5 dollar. At 12% this would over 40 years get you almost 1 million dollar. I would call a required return of more than 12% not 'likely'.
The good news, is that your income will likely increase, and especially if this happens fast things will start to look up. The bad news is, that your current salary is quite low. So, it basically means that you need to make some big jumps in the next few years in order to make this scenario likely.
If you can quickly move your salary towards ranges that are more common in the US, then 15% of your income can build up to a million before you retire. However, if you just follow gradual growth, you would need to get quite lucky to reach a million.
Note that even if reaching a million appears unlikely, it is probably still a good idea to save!
Other people have already demonstrated the effect of compound interest to the question. I'd like to add a totally different perspective.
Note that the article says
if you can follow this simple recipe throughout your working career, you will almost certainly beat out most professional investors [...] you'll likely accumulate enough savings to retire comfortably.
(the latter point may be the more practical mark than the somewhat arbitrary million (rupees? dollars?)
My point here is that the group of people who do put away a substantial fraction of their (lower) early wages and keep them invested for decades show (at least) two traits that will make a very substantial difference to the average (western) person. They may be correlated, though: people who are not tempted or able to resist the temptation to spend (almost) their whole income may be more likely to not touch their savings or investments. (In my country, people like to see themselves as "world champions in savings", but if you talk to people you find that many people talk about saving for the next holidays [as opposed to saving for retirement].)
Also, if you get going this way long before you are able to retire you reach a relative level of independence that can give you a much better position in wage negotiations as you do not need to take the first badly paid job that comes along in order to survive but can afford to wait and look and negotiate for a better job.
Psychologically, it also seems to be easier to consistently keep the increase in your spending below the increase of your income than to reduce spending once you overspent.
There are studies around that find homeowners on average substantially more wealthy than people who keep living in rental appartments (I'm mostly talking Germany, were renting is normal and does not imply poverty - but similar findings have also been described for the US) even though someone who'd take the additional money the homeowner put into their home over the rent and invested in other ways would have yielded more value than the home. The difference is largely attributed to the fact that buying and downpaying a home enforces low spending and saving, and it is found that after some decades of downpayment homeowners often go on to spend less than their socio-economic peers who rent. The group that is described in this question is one that does not even need the mental help of enforcing the savings.
In addition, if this is not about the fixed million but about reaching a level of wealth that allows you to retire: people who have practised moderate spending habits as adults for decades are typically also much better able to get along with less in retirement than others who did went with a high consumption lifestyle instead (e.g. the homeowners again).
My estimate is that these effects compound in a way that is much more important than the "usual" compounding effect of interest - and even more if you look at interest vs. inflation, i.e. the buying power of your investment for everyday life.
Note that they also cause the group in question to be more resilient in case of a market crash than the average person with about no savings (note that market crashes lead to increased risk of job loss).
Slightly off topic: I do not know enough how difficult saving 50 USD out of 50 USD in Pakistan is - and thus cannot comment whether the savings effort called for in the paper is equivalent/higher/lower than what you achieve. I find that trying to keep to student life (i.e. spending that is within the means of a student) for the first professional years can help kick-starting a nest egg (European experience - again, not sure whether applicable in Pakistan).
As others have shown, if you assume that you can get 6% and you invest 15% of a reasonable US salary then you can hit 1 million by the time you retire.
If you invest in property in a market like the UK (where I come from...) then insane house price inflation will do it for you as well. In 1968 my parents bought a house for £8000. They had a mortgage on it for about 75% of the value. They don't live there but that house is now valued at about £750,000. Okay, that's close to 60 years, but with a 55 year working life that's not so unreasonable. If you assume the property market (or the shares market) can go on rising forever... then invest in as much property as you can with your 15% as mortgage payments... and watch the million roll in. Of course, you've also got rent on your property portfolio as well in the intervening years.
However, take the long view. Inflation will hit what a million is worth. In 1968, a million was a ridiculously huge amount of money. Now it's 'Pah, so what, real rich people have billions'. You'll get your million and it will not be enough to retire comfortably on! In 1968 my parents salaries as skilled people were about £2000 a year... equivalent jobs now pay closer to £50,000... 25x salary inflation in the time. Do that again, skilled professional salary in 60 years of £125000 a year... so your million is actually 4 years salary.
Not being relentlessly negative... just suggesting that a financial target like 'own a million (dollars)' isn't a good strategy. 'Own something that yields a decent amount of money' is a better one.
If by being a millionaire you mean dollar millionaire then I doubt that it is really that easy in Pakistani context. At present the exchange rate is 107 Pakistani rupees per US dollar so even with this exchange rate, to have a million US dollars means having 107 million rupees of wealth. Now with this maths in mind you can very well calculate how much possible it is for an average 25 years old Pakistani to have that much wealth. And by the time you have 107 million Pakistani rupees of wealth the exchange rate against the US dollar would have only gone up against Pakistani currency.
That article which you have mentioned makes calculations in US context and dollar terms. However if you talk only in terms of your country's context then being a millionaire means having 1 million rupees of wealth and that is something which is quite achievable with your salary and within very short span of time.
The really simple answer is that compound interest is compound not linear. Money invested for longer earns more interest, and the sooner you start investing, the longer it has to earn interest.
These ideas come out of pension investment where 65 is the usual retirement age and what you invest in the 1st ten years of your pension (or any other compound interest fund) accounts for over 50% of what you will get out.
25 to 65 is forty years and $100 invested at 7% for 40 years is $1400. $100 invested every year for 40 years the pot would be worth just under $20,000. At 30 years, it would be worth under $10,000, and at 20 years it would be worth only $4099.
If you double your investment amount every 10 years you would have invested $15700, and the pot would be worth $45,457. Do exactly the same but starting at 35 instead of 25 and your pot would only be worth $14,200.
The closed-form formula for how much money you will have after Y years, with I annual yield, putting in D dollars each year, is
(D/I)((1+I)^Y-1)
So if you put in $7,500 each year and get a 6% return for 50 years, then you will end up with:
($7500/.06)(1.06^50-1) =
($125000)(18.42-1) =
($125000)(17.42) =
$2,177,519
I just want to point out a couple of things, and I do not have enough reputation to comment.
Saving 50% is totally possible. I know people saving 65%.
For more see here
EDIT:
Let me repeat that 4% it the maximum you can assume if you want to be sure to have at least that return in the long term. It's not the average, it's the minimum, the value you can expect and plan with.
Just to reinforce the claim, I can cite Irrational Exuberance of Robert Schiller, who explicitly says, on page 135 of the 2015 edition, that from January 1966 to January 1992 the real annual return was just 4.1%. Sure, this does not matter so much if you are investing all the way through, but it's still a 26 year period.
Maybe.. Maybe not
I have never liked the 401k scheme.
First and foremost, it is a lock box. Just that alone should give anyone pause about putting too much into the 401k.
If you need money to buy your first house? Well you really can't touch that 401k money without taking a huge penalty (https://www.moneycrashers.com/401k-ira-withdrawal-down-payment-house/). You can borrow against it, but you have to pay yourself back and it counts towards your ability to finance the loan. Well you might say, you can wait on your house... But your house is often your biggest asset and it is often a good investment. It is also a great tax shield. And every dollar you put into paying your own mortgage is a dollar you aren't putting into paying your landlord's mortgage.
Too much 401k too early, I think is a key reason why millennials are delaying their home purchases, which also delays other life events.
But the lockbox problem doesn't end there. It is often a managed lockbox. If you see a great stock opportunity (suppose you want to go all in on Apple after the iphone unveil), well all your money is tied up in your 401k plans. Yes, some employers 401k have a brokerage account (https://www.investopedia.com/articles/personal-finance/061314/rise-401k-brokerage-accounts.asp), but many don't. All things being equal, one should pick an employer with a self managed 401k plan with no restrictions.
This lack of flexibility hurts.
But the problem doesn't end there.
401k is not a pension.
As a result, the performance of your account will be hugely affected by the overall market. If you start your career right at a major crash, count yourself super lucky! You get to start your 401k contribution when things are reasonably priced.
But if you end your career during a major crash then it would be a disaster. (for obvious reasons)
Pension (with a large number of participants of varying ages) takes that volatility out of the equation. The only problem with the pension plan is, they over promise... making it unsustainable. (the real fix for the pension is to lower the promise, or increase the contribution.)
So will you become a millionaire? in 40 years? maybe... but you have to remember by the time you are 65, the purchasing power of that million won't be much...
should you contribute to your 401k? if your company matches, absolutely. You must get the match (that's free money)... but beyond that.. it is really another investment with some pros and quite a few cons.
