Compound Interest: How long will it take to save 1 Million Dollars (Pt1)?

Assuming you make 5% a year after inflation and taxes, here's how long it'll take you to make 1 million (in today's dollars):

Additional Savings Per Year:	$0.00	$5,000.00	$10,000.00	$15,000.00	$20,000.00
Starting Net Worth
$10,000.00	94	47	36	29	25
$20,000.00	80	45	35	29	25
$30,000.00	72	44	34	28	24
$40,000.00	66	42	33	27	24
$50,000.00	61	41	32	27	23
$60,000.00	58	40	31	26	23
$70,000.00	55	38	31	26	22
$80,000.00	52	37	30	25	22
$90,000.00	49	36	29	25	22
$100,000.00	47	35	28	24	21

The takeaway is to start early and save as much as possible.  Your starting net worth doesn't matter as much as how long and how much you choose to save.  More on this later...

The Inflation Bully will steal your money under your Mattress!

If there's risk everywhere in the financial markets and banks aren't safe from collapse and political risks, then keeping money under your mattress is the best option, right?  In the short run, it may be fine, but due to inflation, it'll lose approximately 3% of its value over time.  I think of inflation as a bully that steals 3% of the value of the money under your mattress.  In reality, the prices of goods (assuming equal quality) you purchase every year will most likely go up year after year and this effect is refereed to as Inflation.

There's really little that can be done to predict the inflation rate going into the future but the long-term sustainable rate has historically been around 3%.  So if you keep $100 under the mattress, that same $100 will have around $97 of purchasing power in a year if inflation is 3% after prices have gone up.  Now 3% might not be a big deal but remember, inflation rates compound over time.  Here's a table of how much money you'd need to buy the same goods costing $100 today if inflation stays at a constant 3% and how much that same $100 will buy in the future (in today's dollars):


 

Year	Inflation Adjusted Amount of Today's $100	Purchasing Power of $100 Today
0	100.00	100.00
1	103.00	97.09
2	106.09	94.26
3	109.27	91.51
4	112.55	88.85
5	115.93	86.26
6	119.41	83.75
7	122.99	81.31
8	126.68	78.94
9	130.48	76.64
10	134.39	74.41
11	138.42	72.24
12	142.58	70.14
13	146.85	68.10
14	151.26	66.11
15	155.80	64.19
16	160.47	62.32
17	165.28	60.50
18	170.24	58.74
19	175.35	57.03
20	180.61	55.37
21	186.03	53.75
22	191.61	52.19
23	197.36	50.67
24	203.28	49.19
25	209.38	47.76
26	215.66	46.37
27	222.13	45.02
28	228.79	43.71
29	235.66	42.43
30	242.73	41.20
31	250.01	40.00
32	257.51	38.83
33	265.23	37.70
34	273.19	36.60
35	281.39	35.54
36	289.83	34.50
37	298.52	33.50
38	307.48	32.52
39	316.70	31.58
40	326.20	30.66

In other words, your $100 will be worth about $30.66 in today's dollars 40 years from now and you'll need about $326.20 to buy the same goods $100 will buy today.

But if I keep money in a Savings Account, I can earn interest which will offset inflation, right?

Sometimes, yes.  In recent times (since around 2000), most likely, no.  According to inflationdata.com, the average inflation rate from 2000 to 2009 was about 2.56%.  Since you need to pay taxes on interest on a savings account, you'll need a much higher interest rate to keep up with inflation.  If your tax rate is 30%, you'll need a 3.7% interest rate, and if your tax rate is 40%, you need 4.3%.  Unfortunately, rates have been at 0.25% since 2008 and have only exceeded 4% for only a minority of periods since 2000.  Although some investors don't include Savings Accounts as a legitimate investment vehicle, there are times when it may be prudent to earn interest in a savings account (for example, in the early 1980s when interest rates were vastly higher than inflation.)  But there exists no mandate that the interest paid on savings accounts must keep up with inflation and they have underperformed inflation for long periods in the past, so I don't think it's wise to rely on them for inflation protection.

Why don't I use TIPS instead?  They're designed to keep up with inflation!

TIPS, a government bond that pays you interest based on the inflation rate, sounds like the holy grail to our inflation problem, right?  One problem though: you have to pay taxes on the interest from these bonds.  After paying taxes, you will NEVER beat inflation.  Back to the drawing board..  almost.

Putting TIPS in a tax-exempt or even a tax-deferred account may relieve you of the above problem and actually allow your money to grow at the inflation rate.  These accounts are known as Roth and Traditional IRAs, respectively.  Unfortunately, you cannot withdraw money from these accounts until you are age 59.5 or older.  If you will be 59.5 soon, they may not be a bad idea for inflation protection, but if it's decades away for you, you might as well turn to investing with that long of a time frame.

Want to learn how to get started investing?  Please stay tuned!

Are the Markets a Zero-Sum Game? Yes and No.

This is a common barrier that discourages new entrants to investing and the stock market.  Basically, it states that for every dollar gained in the stock market, another dollar has to be lost by another participant.  In the strictest sense, I can guarantee to you this is not the case, at least not in the long run!  If this were true, then the stock market would not have produced real returns over the last 100 years!  Since the S&P 500 consists of the vast majority of all investable US equities, the average long-term US stock investor would receive a return comparable to the long-term return of the S&P 500 by definition (at least for the US equities portion of his asset allocation.)

Over the short run, the market may seem to be a zero sum game since it's most likely not trending or moving in any decisive direction (up or down) most of the time.  Many books on short-term trading may consider the stock market a zero-sum game and they're pretty much right - the average investor doesn't gain or lose much (assuming they held through the entire period and didn't panic sell on the dips.)  There's also this notion that you must "take money" away from other (usually less sophisticated) investors in order to build your wealth in the stock market.  These people then believe that in order for them to make money at investing, someone else has to lose money which makes them feel investing is a dog-eat-dog world.

Beating the market, on the other hand, is a Zero-Sum game.  If you think about it, half of all the dollars invested in the stock market will underperform the average and half will outperform.  If the return was, say, 20% last year and you returned 40%, then there exists 1 or more investors who must have performed below the average for this logical balance to exist.  However, since the stock market has outperformed inflation over the long run, the average performing investor, assuming he/she stayed invested, would still have benefited.  (Even a somewhat below average performance would still have created wealth for many long-term investors!)

Investing isn't a race or some endeavor to steal money from other investors.  It's how the free market rewards you for bearing risk and lending your excess capital to companies that need it more.  Sure, some companies might end up being duds but if you diversify properly and hold on to a long-term attitude in your investing, your efforts will likely pay off in the end.  In future posts, we'll explore the right attitude to have when investing.

Troubleshooting Credit Card Hacking: Occasional late fees are inevitable

But don't take this the wrong way and assume that late payments are OK, especially on a regular basis!

If you've got 10 different credit cards with 10 different due dates, even if you check you balance twice a month, you're still bound to run into occasional problems with late fees or overdrafts.  The Margin for Error is simply too high with this activity.  In fact, the average credit card user probably gets charged more fees and interest than what is made back in rewards, otherwise this practice of extending credit card rewards would not be a sustainable business practice!

In my use of credit cards since 1999, I've probably averaged about 1 mishap a year, usually a late payment or an overdraft.  But earning rewards and rarely carrying a balance has definitely paid off in providing me a net monetary gain in this endeavor.  Let's use an example here: suppose Joe Schmo charges $1500 a month and pays off the balance entirely, except that he makes a late payment every 6 months.  The average amount he's charged, including the late fee, overdraft, and/or interest is $40 each time.  He averages 2% in credit card rewards each time (some of his cards only offer 1%, others offer bonus rewards on selected categories).  So he gains $30 in rewards each month on average.  His net gain from his use of credit cards each year is: 12*30 - 2*40 = $280.

If you occasionally carry a balance, make late payments, or incur overdraft fees, do take note and try to stop it from happening in the future but don't beat yourself up and lose sleep over those.  It's not likely gonna have a noticeable effect on your credit score and the rewards you earn will likely cancel out the fees.  If it becomes a regular occurrence (say multiple times a month or several months in a row), then it's probably best to take a time out from collecting rewards.  Pay off all your balances and stick with 1 card (or use cash entirely) at least until you're confident you can pull finances back in order again.