“I wonder if it would actually be possible for every single person to retire a millionaire?”
That very provocative question was posed in the comments by reader mmrempen a few posts back. It’s been rattling around in my brain ever since.
The short answer is a qualified “Yes!” It is possible for every middle class wage earner to retire a millionaire. But it’s never going to happen. And that’s not because the numbers don’t work.
The numbers tell us that, compounded over time, it actually takes very little money invested to grow to $1,000,000. Over the 40 years from January 1975 to January 2015 the market averaged an annual return of ~11.9% with dividends reinvested (~8.68% if you spent your dividends along the way)*. At that rate just $12,000 invested in the S&P 500 stocks in 1975 would be worth over a cool million ($1,077,485) in 2015 (when this post was written).
Don’t have $12,000 lying around? That’s OK. If you started in January 1975 and invested $130 per month ($1,560 a year) by January 2015 you would have had $985,102**. Not quite a million, but not a handful of mud either.
Want nothing less than the full million? Kicking it up an extra $20 to $150 per month, $1,800 a year would have gotten you to $1,136,656**. Your million plus a new Tesla and Corvette.
If you think about it, this is pretty amazing considering all the financial turmoil of the past 40 years. However, it’s important to know that compounding takes time, so it helps to start young. Here are the calculators I used:
- *http://dqydj.net/sp-500-return-calculator/
- **http://dqydj.net/sp-500-dividend-reinvestment-and-periodic-investment-calculator/ (Use: Click to Show Advance and check Ignore Tax, Ignore Fees)
Of course, a million dollars is a very arbitrary goal. Perhaps the better question is: Can everybody achieve financial independence?
Living Small
There are countless stories of people of modest income who by way of frugal living and dedicated savings get there in remarkably short time. You can find some here. If you can live on $7,000 per year, $175,000 gets it done figuring an annual withdrawal rate of 4%.
Then too, I remember having lunch with a friend of mine a few years back just before Christmas. He’d just gotten his annual bonus: $800,000. He spent the lunch complaining that it just wasn’t possible to make ends meet on what he made. Listening to his expenses, he was right. He’s burning thru more than $175k every three months. Financial independence is a distant dream for him.
Money is a very relative thing. Right now I have roughly $100 in my wallet. For some people out there $100,000 has less relative value to their net worth. For others, $1,000,000. For still others it might be more than they’ll see in an entire year.
Being independently wealthy is every bit as much about limiting needs as it is about how much money you have. It has less to do with how much you earn—high income earners go broke while low income earners get there—than what you value. Money can buy many things, none of which are more important than your financial independence. Here’s the simple formula:
Spend less than you earn – invest the surplus – avoid debt
Do simply this and you’ll wind up rich. Not just in money.
If your lifestyle matches or, god forbid exceeds, your income you are no more than a gilded slave.
Let’s consider an example. Suppose you make $25,000 per year and you decide you want to be financially independent. Following some of the examples here you organize your life in such a fashion as to live on $12,500. That’s a 50% saving rate. Two important things immediately happen. You’ve reduced your needs and you’ve created a source of cash with which to invest.
Now let’s use our calculators to play with some scenarios.
Assuming you’ll be financially independent when you can live on 4% of your net worth each year, you’ll need $312,500 ($312,500 x 4% = $12,500). Investing your $12,500 each year in VTSAX and assuming the 11.9% annual return of the market over the last 40 years, you are there ($317,175) in ~11.5 years.***
At this point suppose you say, “OK I’m done with saving and I’m going to double my spending and spend my full earned $25,000 from now on. But I’ll leave my $312,500 nest egg alone.” In 10 short years it will have grown to $961,946*** without you having to add a single dime. That amount yields $38,478 a year at a 4% withdrawal rate. You can now not only quit working, you can give yourself a (rather substantial) raise.
***http://www.calculator.net/investment-calculator.html (use the “end amount” tab)
For simplicity sake, yes, I’ve ignored taxes. But we’ve also assumed you’ll never see an increase in income. We are just doing a bit of “what if” analysis to help see that your money can buy you something far more valuable than trinkets and trash.
But few will ever even see this as an option. There are pervasive and powerful marketing forces at working to obscure the idea that such a choice exists. There’s a lot of money to be made persuading folks they really simply must have the latest in trinkets and the most fashionable of trash.
There is a huge marketing effort designed to keep people spending and in debt slavery. We are relentlessly bombarded with messages telling us that we need this, we must have that and if you don’t have the money, no problem. That’s what credit cards and payday loans are for. This is not an evil conspiracy at work. It is simply business. But it is deadly to your wealth.
The science behind the art of this persuasion is truly impressive and the financial stakes are huge. The lines between need and want are continually and intentionally blurred. Years ago a pal of mine had bought a new video camera. It was the best of the best and he was filming every moment of his young son’s life. In a burst of enthusiasm he said: “You know, Jim, you just can’t raise a child properly without one of these!”
Ah, no. Actually you can. In fact, billions of children have been raised over the course of human history without ever having been videotaped. And, horrific as it may sound, many are still today. Including my own.
You don’t have to go far to meet someone who will tell you about all the things they can’t live without. You likely have your share. But if you want to be wealthy, both by controlling your needs and expanding your assets, it pays to reexamine and question those beliefs.
One of my key objectives with this blog is to present another way. If you’re still not so sure about the cost control part of the equation you might check out:
http://www.mrmoneymustache.com/2012/05/14/first-retire-then-get-rich/
Our pal mmrempen followed up with another question:
“I wonder how much of our economic strength is based on reckless spending, and what would happen to it if EVERYONE started acting more responsibly with their money. I might well be out of the job! After all, who needs to spend so much on movies? (He is a filmmaker and you can check out his work here.)
“It’s no knock on your financial advice, now. Just a thought experiment.”
Still from a mmrempen film
No worries, MMR……my advice should be expected to stand up to a few knocks. 
In fact, the whole wealth building point is to have plenty of money to do with your life as you choose. Some you’ll invest, some you’ll spend and both help drive the economy.
Your concern is based on a widely held view that consumption is the primary driver of economic success. Counterintuitive though it may be, it is only one part of a far more complex mosaic.
The concern that everyone might suddenly become responsible is a classic “non-problem.” “Non” because:
- It is unlikely to happen.
- If it does it will be at a very gradual rate allowing for easy adjustments.
- If it does it would be a very good thing. Less consumption would make for a far more sustainable world. No small consideration with 6.5 billion of us running around. Certainly such a change would cause a round of “creative destruction” as companies making and peddling trinkets and trash faced major adjustments.
- In a society with frugal, debt free, financially independent people the necessary and highly beneficial process of “creative destruction” vital to a dynamic economy is far less traumatic.
Note: The examples in this post are meant to illustrate the power of compounding. It is not to suggest that the market will always return 11.9% over any given time frame. Different periods can and do have vastly different results. If you play with the calculators you can see this in action for yourself.
Addendum: Some suggest the 50% target savings rate used above is too aggressive. Others that it is too wimpy. That’s for you to decide. But if reaching financial independence is important to you, the chart below will give you a good idea as to just how powerful your savings rate can be.
The numbers in the chart above assume an 8% annual investment return and that you’ll live on the classic 4% withdrawal rate which implies assets of 25 times your annual needs. So, this is not a gospel, but a guideline.
The chart is taken from my pal Darrow’s (Can I Retire Yet?) book.
Addendum:
Case Study #14: To Dream the Impossible Dream
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