To quote AC/DC, it “ain’t no fun waiting ’round to be a millionaire.” It seems that when you’re putting money away that you are getting nowhere for a long time. It is similar to going into debt, where the interest payments seem miniscule at first, but then you reach that tipping point where the interest just seems to grow and grow. When saving and investing, it seems like you aren’t building wealth at all, but before you know it, the money you are making from your portfolio is far more than you make from your job. The difference between building a portfolio and going into debt, however, is that you’re getting interest rather than paying it out.
In the last post I provided a cash flow plan for a model family making $60,000 per year after taxes. The cash flow plan was as follows:
Mortgage: $15,000/year ($1250 per month)
Retirement: $9000 per year ($5000 in an IRA and $4000 in a 401K to get the employer match)
College: $3600 per year ($2000 in an educational IRA and the rest in mutual funds or a state college savings plan)
Large Purchase Fund: $6,000 per year ($500 per month into a broad index mutual fund)
Asset Building: $6,000 per year ($500 per month into index mutual funds with individual stocks added periodically)
Living expenses: $22,200 per year ($1700 per month for living, with $500 for groceries, $400 for clothing, $300 for utilities and gasoline, $300 for insurance and property taxes, $200 for entertainment each month and $1800 each year for vacations).
Today I thought I’d see where our model family was after 10, 20, and more years to show how things build up. Now understand this is just a model and I’ve made a lot of simplifications. In reality there would be a lot more twists and turns and different changes in income and expenses. Understand that the point is just to show how wealth builds over time. There will certainly be holes in the model, but then again you can model the drag on a brick falling through the air as a sphere and get results that are 90% of the way to accurate.
The Mortgage:
It is best to get a 15-year fixed mortgage. This provides the lowest interest rate, will be paid off before the kids are ready to go to college and while you still have a lot of time before retirement, and will save you a lot in interest over the life of the loan. The loan would therefore be paid in full between years 10 and 20. Using the mortgage calculator from www.mortgagecalculator.org, assuming a $173,000 loan on a $220,000 home with an interest rate of 3.75% we get:
Mortgage Repayment Summary
$1,258.09
Monthly Payment
$226,457.07
Total of 180 Payments
$53,457.07
Total Interest Paid
After 15 years, our model family would have $1258 per month to add to the budget to either increase saving/investing or pay for things like college expenses. That would be enough to pay for an apartment, clothing, and food for a college student with a bit left over to put a big dent in tuition. After the kids were out of college that could be a very nice vacation each year (or two or three), catch-up payments for retirement, or a nice new car for cash every three years. That’s a good reason to get a 15-year loan instead fo a traditional 30-year that your neighbor is getting.
Retirement Savings:
Our model family is saving $9000 each year. Using the Dave Ramsey Investing Calculator, assuming a $750 monthly investment and a steady rate of return of 12%, we get:
Years Total Value Amount Invested Investment Return Yearly Investment Return
10 Years $177,000 $90,000 $87,000 $19,000
20 Years $726,000 $180,000 $546,000 $78,000
30 Years $2,400,000 $270,000 $2,160,000 $261,000
Here Total Value is the value of the portfolio, Amount Invested is how much cash our family contributed, Investment Return is how much the portfolio has returned total in interest and capital gains, and Yearly Investment Return is how much the portfolio would be generating, on average, each year. Understand that this is treating the portfolio like a bank account, which would not be the case. Some years the investment return would be a lot more. Other years it would be less or even be negative. If there are a few big events in the market, there might be barely more than the amount invested after ten years. For this reason the 20 and 30 year numbers are likely to be closer to accurate than the 10 year numbers.
So after 10 years, the family would start getting about as much in investment return as they would have put into the portfolio, assuming a steady rate of return of about 12% during that period. They would also be getting twice as much in investment return each year as they were investing. In 20 years — about the time our couple is in their 40’s, they would have three-quarters of a million dollars invested. Their yearly returns from the portfolio, on average, would exceed their yearly income from their employment. In 30 years, they would have almost $2.5 M in their portfolio and be gaining a quarter of a million dollars in investment return each year on average. Note that they would be getting as much back in investment return each year as they contributed during all those 30 years! Assuming a 4% withdrawal rate, they could generate about $96,000 per year in income, which would be 50% more than the salary they were receiving.
(Again, this is a rough calculation. The actual amounts could be significantly more or less, depending on when the big moves up in the market occurred, particularly when looking at the 10 year numbers. For example, an individual who started working right before the year 2000 would have seen both the dot-com bubble burst and the mortgage meltdown and would have had difficulty even breaking even after 10 years.)
College Fund:
Using the same Dave Ramsey Investment Calculator, assuming a $300 investment in stock mutual funds for 18 years and getting a 12% annualized return, the family would have over $250,000 for college. This would be enough to attend even the Ivy league schools for cash. Of course, this might be a bit optimistic since it would require staying fully invested in stocks the entire time, which would be a big risk when the child was in high school since a stock market stumble could do some real damage. After 13 years, which would be a good time to start pulling back on the risk a bit by diversifying into bonds and other less volatile assets, they would have more than $125,000 in the college fund. This would not fully cover an Ivy League school, but would make a big dent in one. It would definitely fund a state school. An investment mix of stocks and bonds during the last few years would boost this some more, perhaps into the $150,000-$175,000 range by the time the child was heading to the dorm rooms.
Large Purchase Fund:
This is the fund to pay for the things that would need to be covered eventually such as a new roof, an air conditioning unit, replacement vehicles, and home repairs. Again investing in stock mutual funds and assuming a 12% return (and again, assuming steady returns, which is a BIG IF for short periods of time), at $500 per month this fund would grow to more than $32,000 in four years if no withdrawals were made. If a $8000 vehicle were then purchased, the fund would be still be worth over $71,000 by the eighth year. Obviously returns would not be steady, but if the family had a few good years early on in the markets they would easily develop a fund that would allow cash to be paid for vehicles and home repairs, eliminating the need to go into debt and pay out lots of interest for these expenses one knows are coming at some point.
Asset Building:
Asset building would follow the same trajectory as the large purchase fund, except without the withdrawals to pay for things that break. This money would be able to compound and grow unconstrained until it became large enough to start supplementing income. The values after 10, 20, 30, and 40 years are as follows:
Year Account Value Yearly Market Return
10 years $119,000 $12,500
20 years $489,000 $52,000
30 years $1,640,000 $175,000
40 years $5,201,000 $550,000
So after 20 years – about the time the couple is in their 40’s – they will be able to generate about $50,000 per year on average from their investment account. They could start to withdrawal some of this return (perhaps $5,000 per year) to supplement their incomes and let the rest roll over and continue to grow. Before they reach the age of 50 they will have more than a million dollars in this account, allowing them to easily withdraw maybe $30,000 or more each year to add to their lifestyle and do some pretty phenominal things for cash. They will have also gained financial independence since the income from their investments will exceed their income in many years. The account becomes very substantial by the time they are ready to retire, becoming a large supplement to their retirement accounts.
So, as one can see, even with a modest $60,000 income (and no raises in 40 years), a family can save for retirement, save for college, and build up assets that can be tapped in their 40’s and 50’s to add to their lifestyle and provide financial freedom. It is all just a matter of balancing priorities and allocating cash flow appropriately.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.
