A chance encounter the other day led me to a short discussion with a couple of ultra conservatives. These are people who believe that our system is not rigged and the greatest thing about America is that anyone can become a millionaire… or can they?
So, I put together a spreadsheet and did some actual math. The results are quite interesting and I want to share them all with you.
First, the median income for US households in 2006 was just over $50,000. That median salary includes employee benefits like retirement and insurance, but does not include taxes. This is the median, that means that 50% of US households made less than $50,000 and half made more than $50,000. Since 50k is the median, it makes sense to start there and see if, the majority of US citizens can actually become millionaires.
Using a simple spreadsheet, I set up a model that allows for monthly compounding of any interest earned on savings and investments. I also allowed for 25% taxes. Since I currently make about $50k a year, that 25% tax rate matches my net income each month pretty closely. The model also allows for expenses and the ability to have a person invest at various interest rates.
I’m also using a 46 year run of the model. That would assume that a person started working about the age 25 and retired at about the age of 70. The model doesn’t allow for increases in salary. But honestly, most of the people I know make less than $50k a year and always will. These are people like teachers, professors, law enforcement, retail employees, etc.
I’ll do this in a assumptions/results framework.
The first run was just $50,000 annual income, with a 25% tax rate. If a person was able to save every single dime of that money, then they would have $1,725,000 at the end of year 45 (January year 0 to Dec year 45 is actually 46 years). That doesn’t include a single expense of any kind. So, I guess it’s technically possible, but is it realistic that one lives with mom who pays for everything for one’s entire life?
Now, I’m going to use figures from around where I live. These figures should be roughly valid anywhere in the south and southwest of the US. The northern US might need more heating and less cooling. City residents MIGHT have less need of a car, but rent’s are higher, etc.
First, a 1 bedroom 1 bath apartment in my area goes for around $900 a month. That sounds like a lot, but it can get you a new apartment in the suburbs or an… apartment in the downtown area. There’s a big downtown scene around here.
But, you say, what about rural or not-so city living. Well, there’s some pros there. You can usually get a larger place more cheaply. Notice I didn’t say better. But the number of available apartments tends to be small and job opportunities are severely limited in smaller towns. Besides, the majority (of population growth and employment growth is in metropolitan areas).
So what does that 1 bedroom, 1 bath place do to our lifetime earnings. Well, $900 a month is $10,800 a year. Over 45 years, that’s $486,000 dollars. So starting with zero at age 25 and saving everything except $900 a month for rent brings our lifetime down to $1,173,000 dollars. That’s a huge chunk, in fact, it’s one third of our total income. Which makes sense after all, if 1/3 of each paycheck is rent, then 1/3 of your income is gone.
We’ll talk about buying a house and what a disaster that is for the budget briefly. First, you really need to have a down payment to get a house. That comes from your savings, while you are living in the apartment. So, after some years of savings, you then buy a house. If you don’t buy the house outright, then not only have you lost a big chunk of your savings, but now you still have that payment going out each month.
In other words, you’re starting over in the savings department, except you’re now 30 instead of 25 and have less time to get that million bucks. Of course, now you also have to buy a lawn mower, house insurance, etc. etc. etc. All expenses that you probably won’t have with an apartment. Don’t forget about maintenance. Replacing an AC unit, fridge, even a dishwasher every 5-10 years is expensive and things you don’t have to deal with in an apartment.
So, we’re still north of a million dollars, but no one buys an apartment and doesn’t use electricity, water, gas, etc. So let’s figure those in as well. Again, I’m using my figures, slightly reduced for the size of an apartment. My house with 3 people is very different from a 1 bedroom apartment.
Electricity isn’t too bad. Let’s figure an even $100 a month for that. That’s half of what I pay on average. Gas for the water heater and stove is only about $20 a month, on average. Water, well that depends on where you are. My average is $120 a month. A city a few hundred miles away on the coast has average water bills of about $45 a month. I’ll go with $50 a month for water. So, we’re up to $170 for basic utilities.
With basic utilities we are now just a hair over one million dollars for lifetime earnings. But, we can’t stop yet. We have to have… food.
A single person, living alone and never going out to eat could probably be just fine on $200 a month for food. I’m including toiletries and cleaning supplies in this value. My family of 3 gets by for just less than $400 a month for food and sundries. But with a small child, I have to buy new clothes every year too.
Well, that did it. We are now below one million dollars in lifetime earnings for a person making $50,000 a year. A household making 50k would be worse because there’s more people. You would have to have more than a 1 bedroom apartment and more food and sundries too.
Still, it’s pretty close to one million dollars at $968,760. But let’s look at the life. This is no car, no internet (hah!), no telecommunications (phone, TV, etc), no vacations, no going out to eat, heck not even anything to read. Humans can’t live like that.
OK, let’s add in internet (including netflix) and a cell phone. I’ll average the cost of equipment in over time as well. My phone with a data plan, for two people, is about $160 a month. We’ll half that, our hypothetical kid making 50k a year will need a cell phone. My internet is $50 a month. There’s no competition here and in most of the US, so I’ll use that for basic DSL. So, $130 a month for telecommunications.
Now we’re below $900,000 for lifetime earnings. Still no car. In many cities a car isn’t really a luxury, it’s a necessity. Unless you live in one of the few US cities with a good public transport system (Chicago, New York , DC metro, and a few other), then you have to have a car just to get to the grocery store.
Now a car isn’t good fit for my model because in general a car is something you pay four to six years on then you keep it for another 4-6 years. But we’ll average it out and include gasoline and insurance figures. These are hugely variable, so you can do this model with your own numbers or accept mine.
BTW: I do know people who live with only a bicycle. It’s not very practical in Texas when you would ride to work in 90 degree temps with 80% humidity.
OK, the car, say a decent car, not fancy or anything like that, still you pay about $350 a month. We’ll halve that to pay out over a longer monthly period throughout our model. Then you need insurance. Me with no wrecks ever, no tickets, and my age, I pay about $40 a month for full coverage. Gas, even with my short commute (less than 5 miles), I still use about two tanks a month. Since the price of gas is pretty variable, but not expected to go down to $1 a gallon anytime soon, we’ll go with $65 a month for gasoline.
So, $275 a month for everything. That’s being super generous in my mind. I’m paying $400 a month for my car, another $100 a month for gas and the $40 for insurance. And my car isn’t super nice, it’s big, but very base.
We’re down to just under three-quarters of a million dollars in savings. That’s saving $1350 a month, every single month, for 45 years. Heck, this doesn’t include anything else. No hospital visits, no vacations, heck not even a single bender on a long weekend. And you still don’t get to a million dollars at the end.
This is where investing comes in. “It’s not the value of the savings, it’s investing that really makes people millionaires.” That phrase came up in my conversation. That’s so wrong, I can’t begin to describe it… but I will, because it’s vitally important to the entire point I’m making here.
If you have an interest bearing bank account, go take a look at it. What’s your AYP? For my bank, it’s 1%. Let’s put it this way, for 12 months, the average amount of money in my savings was more than $3,000… my interest earned was $4.
Look at it another way. To figure out how long it takes your money to double at any interest rate, divide your interest rate into 72. That’s how many time periods it takes for your money to double.
For my 1% annual percent interest rate savings account, it takes 72 years!! for the money to double. So if, I put in $10,000, after 72 years, I will have $20,000. That’s all. Seventy two years is almost twice as long as my little model runs for. The average lifespan of in the US is only 78.2 years.
I just checked CD rates and the best in the nation is 1.10%… but only if you invest $25,000. Geez.
Now, what’s the interest rate on your car? Compare that to your interest rate that you earn (when you give the bank your money that they loan out to other people).
I’ve been pretty lucky over the past few years with my retirement account. I’ve been getting 3% interest on my retirement account. That means, if I can maintain it, the money I have in that retirement account today will be worth twice as much… in 24 years. When I’m 65 and (maybe) about to retire.
However, in that amount of time, I will have put in over $200,000 of my own money. So let’s compare interest rates to savings. $200,000 worth of savings vs. $24,000 gained from interest. Hmmmm…
Well, let’s just put that 3% interest rate into our model and see what happens. So, right now we’re saving $1405 a month and over 45 years we’ll end up with $775.560 dollars.
Now, with 3% we save the same amount, but end up with… $1,602,753. Hey, not bad. We actually become millionaires. In fact, we hit 1 million dollars after 34.5 years of saving $1350 a month.
I’d like to consider one other thing. The cost for those student loans. Mrs. Ogre is paying $300 a month for her student loans for her Master’s degree… and will continue to do so for some time.
That $300 a month (in the early years, when you get the most bang for your buck with interest) results a $400,000 drop in your final amount (assuming 3% interest).
Again, that’s not very much of a life. Heck just playing World of Warcraft at $10 a month reduces your final income by $12,000.
The annual cost to own a dog or cat is about $680.
The estimated cost to raise a child to the age of 17 is $150,000.
The average vacation costs $2,000.
A pack of cigarettes a day for a year is $3050.
Average cost of a 4 year-degree with in-state tuition $28,920.
Now, I ran one more model… at what point, given the above stipulations, is it impossible for one to get to 1 million dollars? Now, I’m not including the student loans or WoW.
The answer is $41,500. If you make less than $41,500 a year and don’t have ANY debts and never take any vacation and never go out to eat and don’t smoke and don’t have kids, and don’t have cable or satellite and have your college paid for and never own a cat or dog and live in a 1 bedroom apartment…
you will still NEVER have $1,000,000.
According to the US, the average income of the middle 20% of earners is $44,000. That means the middle class, for all intents and purposes, cannot ever become millionaires. If you have a kid, forget it. If you buy a house, forget it. If you buy a boat, forget it. If you have an accident that requires hospitalization, forget it. (No, medical insurance doesn’t cover everything. Shocking isn’t it?)
Of course, averages like that don’t make a lot of sense. There are many people that don’t have an income, but there are also some people whose yearly income is in the hundreds of millions of dollars.
Can the interest increase such that it’s possible? Sure. The interest rate can also crash and even go negative. Remember, the mutual funds and such that are most likely to get you that interest rate invest in stocks and bonds. Stocks in companies that can fail and bonds that may not be paid back.
One last comment. What about a small businesses? Research from the Small Business Administration suggests that 1/3 of small businesses fail after two years and 56% fail after 4 years. Now, go ask all the small business owners if they are millionaires. Go ahead, I’ll wait. I’m willing to bet that you don’t find a single one… with the possible exceptions of doctors and lawyers.
The middle class and lower class do not start out rich and it is very, very difficult to get rich. Occasionally, you get a Bill Gates and Steve Jobs. But not very often. The game is rigged against the ‘lower classes’. The upper classes look out for each other and provide advance notice on stock prices and such that we can’t get. We’re at the mercy of a system designed by the wealthy to keep them wealthy and us not.