I've been officially old (big 4-0) for a few months now. It occurred to me that 40 year-olds have around 20 years of work experience (depending on high school, college, graduate school degrees).
The other reason I picked 20 years for this article is that the numbers work out. This clip from Something About Mary explains why 20 years is the perfect number:
At first glance 20-years seems like a long time. No one wants to wait 20 years for something right?
I thought the same thing until I realized that Summertime by The Fresh Prince and DJ Jazzy Jeff is 25 years old. We're not even going back to Parents Just Don't Understand. Time can sneak up on you.
So how do you get to a million dollars in 20 years? I decided to work backwards with two assumptions that I considered safe:
- You are going to save some amount of money each year and invest it.
- The investment is going to earn 7% a year. While that number will vary, this 7% is generally accepted as a rate of return when investing in stock indexes.
What's the magic number you need to save and invest each year? Let's see if you can spot it:
(It's my first time publishing a Google Sheets document on the web, so hopefully this is a link where you can view the sheet and calculations. If anyone sees anything wrong or has any tips on how I can do this better in the future, please leave a comment below.)
Yep, it's $23,000. By the end of the 20 years you'll have invested "only" $460,000. (We'll get to the "only" in a bit). The investment gains will be $540,000**.
When I did the math, the $23,000 number surprised me. Why? The maximum amount a person can contribute to a 401k plan is $18,000. The maximum a person can (typically) contribute to a Roth IRA is $5,500. If you were to max out both, you'd be saving and investing $23,500.
To all the conspiracy theorists out there, doesn't it appear that the government set these numbers because they want you to become a millionaire in 20 years?
How Can I Save $23,000 a Year?
Saving $23,000 a year can be easy for those with big incomes or an enormous challenge for those with small incomes. There's no one "right" way to get that money to save. I think it's best to work with a blended approach.
The first thing I'd do is track your finances through Personal Capital. Many people are surprised to find out that their restaurant spending is several thousand dollars a year. You might be able to save a couple thousand dollars at restaurants with these tips.
I would try to put as much money as I can in a 401k. Why? Because it's pre-tax money, you won't notice as big a hit in your paycheck. (Yes, you'll pay taxes later**, but psychologically, you'll get a big boost from the big number in the 401k.)
Next, I'd sign up with Digit. This free service takes a small amount of money out of your banking account and "hides" it in another FDIC insured account. The idea is that you won't miss the money the money you don't see. I wrote a review after I used it briefly: Digit Saved me Over $100 in One Week! Now that I've used it for more than a year, I can say that it hid about $4000 that I didn't notice.
By now you are probably seeing that you may be able to save a few thousand here and there. It really depends on what you are already spending and what you are earning. Over 20 years you'll probably need to buy a new car. You may be able to get a car that is cheaper and save yourself a hundred or two a month, which really adds up.
Does saving $23,000 still sound like too much money? Get a spouse and you can cut the savings goal in half. Some may consider it cheating, but I think most people would consider a great joint accomplishment. When I got married I found that many expenses, rent, utilities, cable, were cut in half as I had someone sharing them.
* When I was 23, I was introduced to a 27 year-old woman. I flat-out called her "old". Perspective is a strange thing.
** I'm glossing over a few details such as:
- Investment Expenses - These can be minimized with index investing.
- Inflation - A million in 20 years is likely going to buy less than it does today. On the flip side, it should be easier to save $23,000 in year 18 than in year 1.
- Taxes - This is a big one. I'm going to do what everyone else tends to do and suggest that this is in a retirement account and that there are no taxes when they are really just deferred. I think most people with a million dollars in their retirement accounts would call themselves a millionaire. Am I wrong?