So you want to be a millionaire? Save, save, save.(Read article summary)
The first million is the hardest to make but it gets easier after that. There are three important things to learn- start saving (the earlier the better), save a big percentage of your income, and investment returns don't matter as much as your saving rate.
AP Photo/Wally Santana/File
Recently I fielded an interesting question from a young investor: “How can an average college grad accumulate $1 million?”
Now, $1 million is not what it used to be. It is certainly not the ticket to the good life that it was 20 or 30 years ago. But it’s still a really nice down payment on it. Plus, they always say the first million is the hardest.
I decided to conduct a little thought experiment to determine what it would take someone graduating from college, from a standing start, to accumulate $1 million. According to the National Association for Colleges and Employers, the average starting salary for a college graduate was about $45,000. Additionally, the Bureau of Labor Statistics shows that the unemployment rate for those with a bachelor’s degree or higher is 3.2% as of November. So it seems like a good assumption that a bachelor’s graduate could reasonably expect to find employment, even in today’s slow growth economy. I constructed a little spreadsheet with the following assumptions:
- Starting salary of $45,000
- 3% raise per year
- 10% initial savings rate of gross (pre-tax) salary
- Every year 50% of our grad’s raise goes to increase savings
- Earnings on investment of 6.5%
And the result: 25 years. Which means if you started at age 22, you could reasonably expect, depending on your investment returns, to have $1 million by age 47.
There are some interesting details in this thought exercise. If you follow the assumptions above, you will be saving over 50% of your income by the time you are 50. I suspect that this is not a reasonable assumption for most people (although it works great for this guy). If you change the assumptions to stop raising your contribution level once you hit 25% of your salary (year 11), then you don’t hit a million for 28 years, or a decrepit 50 years old. How about if you start saving 25% of your salary in Year One, and never change it? Same result: 25 years. How about higher investment returns? At a 7.5% average return, you shave one year off your goal and get there in 24 years.
What can we learn from this exercise? Here are three important things:
- You need to start saving—the earlier the better.
- You need to save a significant portion of your income. You can either start high and leave it, or start low and increase every year. But you need to get to a big percentage of savings.
- Investment returns don’t matter as much as your saving rate.
The good news: Once you reach the $1 million mark, it gets easier. If you never contribute another dime, you can expect to get your second million 12 years later; and your third, nine years after that. Maybe the first million really is the hardest.
By Brian McCann
Learn more about Brian on NerdWallet’s Ask an Advisor