Many people think that becoming a millionaire is a result of a major event, like selling a company in Silicon Valley. In reality, you can make $1 million without any special skills, knowledge or luck, just by following basic investment advice.
That’s right — the Average Joe can become a millionaire. You can even do it on a salary of $40,000 per year.
You don’t need to start and sell a major company. You don’t need to pick amazing stocks. All you need to do is follow tried and true advice, and you can make $1 million by doing nothing more than investing in basic broad market index funds, such as the S&P 500 (^GSPC). Here’s how it works.
How to Invest Like a Millionaire
Let’s say at age 25, you begin earning $40,000 annually. This provides you with an income of $3,333 per month before taxes. Set aside $600 per month (18 percent of your gross income). Invest that $600 in a tax-advantaged retirement account, such as a 401(k) or an IRA. From there, select a passively managed index fund that tracks the Dow Jones industrial average (^DJI). It’s that simple.
You don’t have to do anything fancy like day trading or stock picking. You don’t have to flip houses or chase the latest fad. You just track the overall stock market through a low-fee index fund that tracks the Dow Jones. This gives you access to the 30 of the biggest publicly traded companies in the U.S.
Let’s assume your money will grow at 7 percent annually. That’s a conservative estimate, but it’s one Warren Buffett agrees with. Stocks have historically grown at a rate of about 8 percent to 9 percnt annually. However, the precise number varies depending on which range of years you’re looking at, so we’ll assume a 7 percent annualized average as a conservative estimate.
The Power of Compound Growth
Continue to contribute $600 per month into this fund every year. Don’t withdraw it; let it remain in the market. It will reinvest its own dividends and capital gains. You’ll reap the benefits of compound growth. After 34 years, this will grow into $1 million.
In other words, if you begin investing at age 25, you’ll be a millionaire by age 60. Pause and think about that for a second. You can earn $40,000 per year, save 18 percent of your gross income, and retire a millionaire. Just $600 per month, invested conservatively over 34 years, with an annual growth of 7 percent, is powerful enough to change your life.
That’s fairly remarkable given the average American has only $58,000 in a retirement account.
We’re not talking about mega returns. We’re not talking about saving 50 percent to 60 percent of your income. We’re not talking about doing anything extreme.
Imagine that you bumped your savings rate by another 2 percent. Now you’re saving $667 per month, instead of $600. This one move shaves two years off of your timeline. If you start investing at age 25, you’ll retire a millionaire at age 58 instead of 60.
Yes, a mere $67 a month — the price of cable — can help you achieve your goals two years earlier. That’s all thanks to the power of compound growth over time.
How to Combat Inflation
Thanks to inflation, $1 million in 30 years won’t be worth the same as $1 million today. However, if inflation continues to run 3 percent annually and your investments gain at 7 percent annually, you’re still outpacing inflation by more than double its rate.
Want to protect yourself against inflation even more? I recommend using the investment strategy we just reviewed, coupled with also paying off your mortgage. Eliminating your mortgage gives you the following benefits:
- You’ll retire with a guaranteed place to live.
- You won’t have to worry about making mortgage payments in retirement.
- The value of your home will keep pace with inflation over time, assuming it’s not in a severely declining market (such as Detroit).
The Math Still Works
Further, in our example, your salary remains $40,000 from age 25 to 55. It’s declining with inflation, yet the math still works out to $1 million.
We’re also assuming you’ll continue contributing the same $600 per month to your investments, an amount that declines with inflation over time.
It’s likely you’ll grow your salary and retirement contributions at the rate of inflation. This puts you much further ahead than if you were to continue contributing the same raw $600 over 34 years.
Any way you put it, you’ll be able to retire a millionaire just by starting early, being diligent, and riding out the ups and downs of the market.