(This is the first in a series of blog posts on Personal Finance Fallacies. Stay tuned for at least four more posts in the series, released every Wednesday at 9:00 AM MDT.)
As a kid, I thought millionaires were rare--that the only way to become one was to strike gold, either literally or metaphorically. You were either an entertainer, a business tycoon, or an heir of one of those. Most people still feel this way: "There's no way I'll be a millionaire! I don't have the right income to save up that much!"
Turn out, you probably do have enough of an income. But more likely than not, you're crippling yourself from reaching that elusive seven-figure number.
Where does your income go every month? Well, there are the basic living expenses: food, housing, clothing, transportation, and utilities. These basic necessities take up less of your income than you might think! The rest of our income is spent on things like entertainment, eating out, new furniture, new toys, new carpet, a new car, the latest electronics, 695 channels you hate and only five that you like, and last but not least, Amazon. (Enough said.)
Oh, and not only are you buying all of these things, many of them are financed! So you have 20 extra monthly payments and pay hundreds of dollars in interest in order to portray a lifestyle that you're well off, when in reality, you're broke. Just like the Joneses up the street that you're trying to keep up with. Yeah. They're broke too.
"Well, hold on, Aaron, what does this have to do with becoming a millionaire?" All of these "extra" purchases and debt payments are crippling your income each month, when you could be investing that part of your income and letting it grow! Your affluent facade is exactly the thing keeping you from a genuinely wealthy lifestyle.
Let's do a quick exercise. Do you have Excel? Pull it up. We're going to be using the PMT function. This will calculate the amount of money you need to save every month in order to reach $1 million by retirement. Ready? Here's the function:
We'll assume a 10% annual interest rate, which should be easy enough to get, on average. So "rate" per month is 0.1/12. The rest of the data should be based on your own circumstance: "nper" (number of periods) is the number of months until you retire; "pv" (present value) is your current retirement savings balance expressed as a negative; and "fv" (future value) is your retirement goal--in this example, $1,000,000. (We can skip "[type]" in this exercise.)
To make sure you got it, I'll use an example. Let's say I'm 40 years old, I plan to retire at age 65 (12 months for 25 years is 300 months), and I have a measly $20,000 currently saved up in my 401(k). My formula would look like this:
The result should be expressed as a negative, you can ignore that. (Ask me later if you want to know why it and the "pv" amount are negative.) For my example, I calculated that in order to grow my $20,000 to be $1 million over the next 25 years at an average 10% in annual interest, I need to contribute $571.93 every month.
Now look at the amount you calculated. Does it surprise you? Could you set aside that amount each month if it meant retiring with $1 million?
Here's what I mean about all of those "extras" and debt payments crippling your income. If you didn't have any debt payments, would you be able to afford your monthly retirement contribution?
Depending on your age and income, you still may not be able to make it. But I bet that most of you reading this have just learned that millionaire status is within reach! As for the rest of you, you can consider whether you should contribute more each month to try to "catch up"!
There are millions of people in America alone, who are quietly millionaires. They didn't get there because they inherited the money. They were neither business geniuses or entertainers. They consistently and steadily saved and invested. They budgeted. It didn't happen by accident; it happened with careful planning.
You can do it too!
(Look out for a future blog post on why it's important to accumulate wealth!)
(Watch this video to hear "Uncle Dave" Ramsey give us a harsh reality check on becoming a millionaire!)
(If the video doesn't work, click this YouTube link to watch it directly on YouTube.)