Making $1,000,000 may seem like an impossible goal, but it is more attainable than you think. First, it is important to distinguish between making money and saving money.
Sources of income:
Your savings are how much of this income you keep after taxes and expenses. We will talk more about savings rates below.
Source: US Census
If you need a refresher; average is the sum of all incomes divided by the number of households. This number can include billionaires and people with very little income. Median is the middle household income number. This means half of household incomes will be above the median and half will be below.
Clearly, the biggest tool you have for building wealth is your income. Increasing your income can take years off the time it takes you to reach one million dollars.
Sixteen is the age where you can work full time and sixty-seven is the retirement age for most people still working. Most college students graduate around the age of twenty-two. This means most people will work forty to fifty years; possibly even more. Given this timeline, almost every income level on the list will reach a million dollars made. You may be well on your way to a million without having realized it. Now the question is how do we keep as much of this $1,000,000 as possible.
Your income is only one factor in the million-dollar equation. The second piece and equally important piece is your savings rate.
Savings Rate = (the money left over after taxes and expenses + the money contributed towards retirement) / net income
Savings rate can be calculated on a monthly and annual basis. We encourage tracking of both. You have the option of using gross income or net income in the denominator. Gross income is all the income you make before taxes and deductions. Net income is gross income after taxes and deductions. Deductions can include 401(k) contributions, insurance payments, wage garnishments, and more. We use net income because taxes are unavoidable and prefer to exclude them from the calculation. The most important part about tracking your savings rate is tracking the method that works best for you and staying consistent.
It is important to note that the savings rate includes adding back retirement contributions included in income deductions. We do this because these contributions are discretionary and contribute to your savings in the form of a retirement account.
The best savings rate is as much as possible. Just like most aspects of personal finance, this will depend on your situation. A common savings rate goal is 20%. We think this is the bare minimum and works well as a good starting point. Our target rate at The Money Checklist is 50% or more.
There are two limiting factors to achieve a high savings rate.
Your income is your biggest wealth-building tool. We believe in constantly learning and growing your skillset to take advantage of career growth opportunities when they arise. Maybe you have a side-hustle to help boost your income. The greater the income the greater the chance of a bigger savings rate after expenses.
Your expenses are the piece of the equation you will have the most control over and also the area that can destroy your savings rate. There are a surprising amount of people living beyond their means, even with a six-figure income. It is easy to experience lifestyle creep and keep spending more as you make more.
We recommend completing a monthly budget to truly understand where your money is coming from and where it is going. This is the best way to identify bad habits and find ways to increase your savings rate. You may find it difficult to set up your first budget, but it will get easier after a few months. You will most likely find some surprising insights even if you think you have a good handle on your finances.
When you set a plan for your monthly spending, it will cause you to be more purposeful in the way you spend. You will get more accurate each month, and variances will be less frequent. You will be able to fully understand how much you can save each month when you cut out or reduce unnecessary expenses.
There are a few steps we recommend before you really start to build your net worth. We recommend following these steps in order for most people.
The first thing we recommend doing with your savings is building an emergency fund. An emergency fund is a sum of money in a checking or savings account that is held only for unexpected and unavoidable expenses. At a bare minimum, you should have the greater of $1,000 or one month of average expenses set aside. We recommend having six months worth of expenses saved to account for catastrophic situations like COVID-19. An emergency fund should only be used for emergencies and not as additional savings to be constantly dipped into.
Examples of emergency expenses
If your employer offers a match in your retirement account, take advantage of it! Here is how an employer match works. You will have the option to contribute a percentage of your paycheck to your retirement account. When you do, your employer will also contribute to your retirement account based on the retirement plan rules.
Employers can have a partial match up to a limited percentage.
Example:
This means you would have to contribute 8% of your income to equal the 4% limit from your employer. If they had a 100% match, you would only need to contribute 4% to meet the full match.
Another limitation your employer can impose is a vesting timeline. This timeline requires you to work at a company for a predetermined number of years before the employer contributions made to your retirement account become yours.
Example:
If you were to leave the company after three years of employment, only 50% of the employer contributions would remain in your retirement account. !00% of your own contributions to your account will always remain yours, no matter when you leave.
Debt will be the biggest obstacle holding you back from building your savings rate and your wealth. The longer you have debt, the more interest you will pay. All this time you are busy paying somebody else is holding you back from paying yourself. Think about all the things you could do with the money you are paying for your credit card or student loans every month.
We recommend getting out of all non-mortgage debt as fast as possible. We don't include mortgage debt in this step because mortgage interest rates are typically well below the market return. This makes investing a smarter plan for your money. While this may be true for the interest rates on some of your other debts, we only recommend it for your mortgage.
The reasons we want to close these other debts are uncertainty and opportunity. Your circumstances in life could change quickly. Your income could drop, you could lose your job, or you could have a medical issue that changes your ability to work. If any of these things were to happen, your debt obligation would not change. We want to remove this uncertainty and stress as fast as possible and avoid further debt.
There are two popular methods for paying off debt:
When all these loans are paid, it frees up a lot of extra money to take advantage of. This allows us to complete our emergency fund and invest.
Without investing it will be very difficult to reach $1,000,000 in savings.
Investment accounts can be 401(k)s, 403(b)s, IRAs, individual brokerage accounts, and more. Whatever the type, your investments will be the biggest tool in keeping more of the million you make in gross income.
Let's look at an example of three households.
Key Takeaways
After ten years household one had $55,266 saved, household two $69,082, and household three $103,623.
Although household one makes over three times as much as household three, they ended up with about half of the savings as household three after 10 years. This shows the power of a high savings rate.
If household one had a 25% savings rate, they would have almost $350,000 saved after 10 years!
In assumption 4 of our previous example, we assumed a 7% annual return. This return comes in the form of investment value growth. An example would be buying a stock for $100 on January 1st. On December 31st the market value of the stock is $107. This is a 7% annual investment growth (return).
Returns compound when you make returns on your returns.
In this example, we made a 7% return on our $100 investment for a total year one return of $7.
In year two we made a 7% return on our $100 investment plus a 7% return on the $7 gained in year one. Our year two return was $7.49 even though we didn't invest any more money and the rate of return did not change.
This growth on returns will continue to grow over time and grow at a larger rate the longer the period.
Let's look at the 7% rate of return and 25 year time period.
If it isn't fully clear, time invested in the market is the most important factor for growth. Every year you wait makes it harder and more expensive to catch up. Making $1,000,000 is not as out of reach as you may have thought. The math is simple and it requires simply investing over and over until one day there is an extra comma in your account. Use our chart to get an idea of your timeline and expected rate of return and develop a plan for success. The time to start is right now.
