You ever wonder what it actually takes to get a million dollars via being frugal and saving? Everyone loves talking about pinching pennies, but how much do I have to save to get that sweet millionaire status?
The following assumptions have been made:
- Inflation: 2.8%
- Rate of Return: 9.0% (many funds outperform this long-term)
- Ignore Taxes (utilization of ROTH IRA or getting additional pre-tax dollars via 401k makes this a viable assumption, we are talking about saving after-tax dollars)
Below is what a single dollar (increasing over time with inflation) saved per month would look like in 30 years if invested.
So what’s the message with the chart above?
Saving a dollar (inflation adjusted) a month isn’t even close to enough to make any sort of material difference in your life (of course this is expected). A dollar per month is roughly $1,040 inflation adjusted after 30 years. Just for your information: You would have put in $563.20 worth of additions over the 30 years to obtain that $2,403 before inflation number.
So what would you need to save to have an inflation adjusted million dollars (million dollars in today’s terms)?
The answer, thanks to goal seek in excel is, $960.7 a month plus inflation over time. Meaning that $960.70 contribution would become $1,267.7 in year 10, $1,676.8 in year 20, and so forth. In theory, the monthly contribution should feel the same every month if your income increases with inflation, although that doesn’t seem to be the case (especially now a days). The chart below shows how that $960.70 contribution per month plays out.
To some, this chart is completely overwhelming. To others, it might be a relief. It’s very subjective, but I’m here to appeal to a very specific audience, the lower middle class.
Let’s imagine you take home roughly $50,000 a year and that your take home pay will increase with inflation.
You would need to save $11,667 a year, roughly 23.3% everything coming into your household. It’s do-able, but with one giant caveat (warning).
You have to keep your “fixed” base expenses low, or this is simply not going to be viable. Let’s take a look an example household.
You have $4,166 a month coming in (from your $50,000 take home a month), but let’s call it $4,200 even.
Maybe your household budget looks something like this:
Note: Adjust as needed, just to illustrate there are minimum base expenses in every household.
- Frugal Food Budget (4 People): $900 a month (roughly $7.50 per person per day)
- Car Expenses (everything including gas): $300 a month
- Cell Phone: $120 a month
- Health Expenses: $200 a month
- Entertainment/Travel: $400 a month (even one small trip a year could use more)
- Clothing: $150 a month
- General Merchandise/Hobbies: $150 a month
- Internet: $60 a month
- Netflix/Hulu: $24 a month
- Gifts/Donations: $100 a month (birthday parties, x-mas, donations, holidays)
We’re at $2,404 a month, and these expenses are for the most part relatively unavoidable without extreme measures. But we are missing one major component (arguably the largest component for most lower middle class), housing. This ties right back to the article I previously wrote entitled “Why Your Home Will Keep You From Being Wealthy.”
Why Housing is So Important (Most Can’t Save Without Going Smaller)
So of your $4,200 take home you already spent roughly $2,404 (and you’re living fairly frugally/minimalists, not much dining out, no massive international traveling, no luxury goods, etc.). You have $1,796 left to spend per month and you need to save $960 a month, meaning you can spend no more than $836 a month on housing and utilities if you want to save and invest your way to an inflation adjusted million dollars in 30 years.
The killer point here is that people rarely spend that little on housing. Now you can work all the black magic with appreciation and equity you want, but it’s fairly unlikely you are spending a net $836 a month after you include:
- PMI (if applicable)
- Maintenance on the Home
- Updates on the Home
- Realtor Fees/Closing Costs (if applicable)
Now it is possible that if you had appreciation, equity building, very low utilities, no updates in your home, low maintenance on your home, or cheap insurance; maybe you could get to a “net” $836. Sadly even if you show a paper cost of $836, that’s not good enough. Your equity and appreciation are locked up, it’s on paper only (not cash flow). Hence, your home has the potential to keep you from your maximum potential. Let’s really beat this point to death, because it’s vital.
Just a Brief Example of Why the Math of Housing (Appreciation/Equity) Doesn’t work in your Favor:
Let’s imagine you are considering two houses, a $250k house or a $100k cheap house.
$250k House (Assume you put 20% Down)
- Costs More to Maintain (which grows with inflation)
- Costs More to Heat and Cool (which grows with inflation)
- Costs More in Taxes (which grows with inflation)
- Costs More in Insurance (which grows with inflation)
- Costs More to Furniture (which grows with inflation)
- Costs More to Update (which grows with inflation)
- More Fees to Sell (will ignore in numbers, but you are down $9k more than 100k house day one)
- More time Clean (will ignore in numbers)
- Larger Deduction (but you only get back your marginal rate back)
- Larger Equity Build (but on paper and locked to 2.8% return)
- Larger Appreciation (on paper and locked into 2.8% return)
- More volatility if market turns (could get stuck)
$100k House (Assume you put 5% Down, taking a minimal PMI hit of about $50-75 a month until 22% equity)
- Lower Taxes
- Lower Insurance
- Lower Utility (probably)
- Lower Furnishing Costs (if smaller)
- Lower Maintenance
- Less Stress
- More Flexibility to Move
- Less Fees to Sell (will ignore in Numbers)
- Less Equity Build (on paper and locked to 2.8% return)
- Less Appreciation (on paper and locked to 2.8% return)
- Smaller Deduction (but it’s because you spent less in interest and taxes)
Let’s assume you spend $500 a month less on the smaller house (which is EXTREMELY conservative, it’s likely a lot more than that). Let’s also assume you take the difference between the down payment between each house and invest it. What would the difference be in 30 years?
Well if you bought the $250k house, you would own a nicer more inflated house worth a lot more.
If you bought the cheap house you would have an (1) inflated smaller house, (2) whatever the invested down payment is worth, and (3) the invested $6,000 per year + inflation (that you didn’t spend by going smaller).
The difference, $1,276,014 over 30 years. I would also argue that’s very conservative and doesn’t even weigh all of the other benefits of owning a smaller house. Think about it this way, you’re pushing having four big houses of net worth.
Important Point: Housing Appreciation is Unknown (even more so than stock market, in my opinion)
It’s possible housing will appreciation 300% over inflation for the next 30 years, but frankly it’s unlikely to do so without it’s bubbles and busts. Just think about the idea of housing going up three times the rate of inflation, how would someone afford these houses? This article made the assumption that housing would peg to inflation. Assuming the housing market will peg to inflation is arguably too favorable to housing. If you want to make assumptions like “my house will grow at 5% a year for the next 30 years,” I would argue that the stock market would still out pace housing (since it’s likely that massive +332% housing price is as a side effect of inflation). There is a great article on CNN about this exact subject (link). Let’s put it this way, since the early 1990’s, housing versus stocks hasn’t even been close (stocks by a landslide). But to be fair, that’s only 25 years.
Remember, Cash Flow is King not Paper Illiquid Gains
The point of this article is, you need $960 plus inflation a month to hit that adjusted million dollars. That means $960 of cash + inflation has to flow to an investment vehicle that hits 9% a year. That’s $32 a day. Being frugal is one thing, but unless you reduce your base expenses substantially, it’s going to be a struggle for most people to save that much per day. I’ve said it a million times, smaller housing is the key.
By reducing the size of your home, you reduce maintenance, utilities, upgrade costs, time to take car of, furniture costs, and so much more (not just financial). The $960 a month might be overwhelming to some, but what if you really sized down your house and saved a net $500 a month on your housing? Doesn’t $460 a month sound much more reasonable? Once you lock into that smaller house, that $500 a month will come naturally. The remaining $460 a month can come from living frugally.
That’s a preview of what it takes to get an inflation adjusted Million Dollars in the next 30 years.