How to
Become a
Millionaire on
$40,000 Per Year
by Mark L. Alch, Ph.D.
You
can become a millionaire on $40,000 a year. Sound impossible?
Well, it is not.
You see, most millionaires
do not lead glamorous lives. Most millionaires are people not
unlike you. Many of them are entrepreneurs or work for themselves,
but just as many others have regular jobs like you do.
Your job does not even
have to pay you a lot of money. If you have a job, all you have
to do is keep it. If you want to become a millionaire, you must
remember this: It is not how much money you make, it is how much
money you keep.
Most millionaires are ordinary, hard-working people with a passion
for what they do and for socking away their money. Here is what
it takes to become a millionaire in net worth (meaning the things
you owe, minus the things you owe on, are worth at least $1 million):
- Sufficient income over a long period of time (but not necessarily a lot).
- Living well below your means to have the discretionary income to invest.
- Pay yourself first (your investment), as if this were a mortgage or an insurance policyactually, it is of a sort because Social Security may not be able to pay out full benefits in the coming decades.
- Resist the temptation to spend the invested gains. Economists call this the "wealth effect" where people feel richer as a result of the run-up in the stock market or increased value in their home. The tendency is for people to sell off their stocks or take out a home equity loan to buy expensive cars, big boats, or take exotic vacations.
Here are three easiest ways to become a millionaire:
- Take advantage to the fullest your companys 401(k) [or 403(b) plan in the nonprofit sector] and any other company-sponsored contribution plans. Today, there are 30 million workers who have $1.5 trillion invested in 401(k)s which amounts to about $50,000 per worker. Also, put extra disposable income in independent stock accounts, mutual funds, and individual retirement accounts (IRAs) for added measure. An estimated 48 percent of American families now own stocks directly or through mutual funds compared to 32 percent in the late 1980s. The value of the entire U.S. stock market has grown from $1 trillion in 1982 to $13 trillion in 2000. As a rule of thumb, start out saving at least 10 percent of your gross income and increase it as your income rises.
- Buy a home and live in it until retirement. The majority of millionaires fit this category. As a familys income rises, rather than buying a larger home with a huge mortgage, they use the extra disposable income for their investments. On the other hand, most families trade up their house on the average of every 5.2 years, according to the U.S. Census Bureau. In 1993, the last year in which statistics are available, only 15.3 percent of families had lived in the same house for twenty years or more.
- Purchase a pre-owned car and drive it for no less than 12 years, preferably 20 to 25 years. According to the National Automobile Dealers Association, the mean age an average American family keeps a car is now 9 years, up from 8.6 years in 1996. In comparison to the high-net-worth ($100,000 in income and $1 million in investments), a high income-low net worth household ($100,000 in earnings but little in savings) might purchase or lease a new car every 2 to 5 years. Again, as a familys income increases, the savings in not buying a new car is put to use in investments. Paying cash for a used car (3 to 5 years old when depreciation is greatest) and then repaying yourself is the third way to accumulate $1 million net worth by the time you are 65 years of age.
Old-fashioned
discipline, determination, and persistence in saving and investing
and not throwing away money on high mortgage and car payments
are far more important than a high income. For every $1 spent,
a worker has to earn approximately $2, since the combination
of federal and state income taxes and state and local sales taxes
take about half of our earnings. Millionaires have learned this
lesson well.
This information seems to be lost on the majority of people in
the middle-income bracket. Primeamerica, a financial services
firm, and the Consumer Federation of America undertook a telephone
poll of 1,010 Americans 18 years of age and older from July 22-25,
1999. The random survey found that most Americans undervalue
the extent to which savings can accumulate over time. The respondents
were asked how much $25 invested weekly ($1,300 per year) over
40 years at a 7% annual yield would amount to. Fewer than one-third
guessed over $150,000. The correct answer is $286,640. With a
traditional stock market return of 10% per year, the figure would
be over $500,000. If the spouse or significant other also put
away $1,300 per year (less than 5% of gross earnings at $40,000
per year) at 10% interest for 40 years, the household would be
millionaire-status.
A series of similar
questions found that younger and lower-income Americans had the
most problem understanding the geometrical progression involved
in compounding money. The survey suggested that misconceptions
about how small amounts of money can increase over time might
be preventing some people from taking the necessary steps to
improve their lot. In a question designed to illustrate such
misconceptions, the survey found that 27 percent of Americans
believed that winning a lottery or sweepstake is their best chance
to obtain $500,000 or more in their lifetime. Among households
with annual incomes of $35,000 or less holding to that belief
jumped to 40 percent.
Similar results occurred
in a poll conducted among average New Yorkers. On November 10,
1999, prior to a live segment the following day on CNNfn "Before
Hours" hosted by Jack Cafferty on How to Become a Millionaire,
a CNN film crew took to the street to interview New York commuters.
The question asked was "how do you become a millionaire."
The most frequent response was, "I dont know" followed
by "marry one."
For the majority of
working Americans, putting away just 5% of their gross earnings
can put them into a high investment category over the long haul.
At a 10% interest per year, the money would double every 7.2
years even without putting additional money into savings. This
is the "rule of 72" where dividing the interest rate
into 72 will give the number of years it will take to double
an investment. For example, if you only receive 3% on a savings
passbook account through a bank, then 3 divided into 72 is 24.
It will then take 24 years to double the money, without putting
additional money into the account. By maximizing the amount of
money you put into your investments you can reach your target
in a shorter time. You dont necessarily have to start investing
when you are in your 20s to hit the $1 million mark. Millions
of Americans can start in their 40s and 50s without much financial
sacrifice.
One way people can increase their investments quickly, easily,
and painlessly is to take advantage of pay raises, bonuses, and
commissions, by putting more money away, because the money will
not be missed. After all, it is hard to miss money if one never
sees it in the take-home pay.
Consider a single person
earning $40,000 per year and putting away 15 percent into a 401(k)
and the employer matching 50% of the contribution, which is very
common. At a return of 10% interest per year, which is a reasonable
rate to assume, the fund would have $1 million (actually $1,229,338)
in 25 years and this would be automatic. If that same investor
resisted purchasing a new car or a new home, it would be possible
to cut the amount of time in halfto about 12.5 years. If a working
couple, each earning $40,000 per year, put away 15 percent of
their earnings into a 401(k) plan and the employer matched 50%
of the contribution, a couple would hit $1 million net worth
in 19 years. Again, as in the example above, it is possible to
cut the amount of time in half to around 10 years by not making
upscale home and car purchases.
Considering that the
couple will have more money coming in from their investments
than their salaries, they will now have the funds to do what
they have always desired to do. One million dollars net worth
earning 10% interest per year, what the stock market has traditionally
earned in the last sixty-five years, comes to $100,000 per year
or $8,333 per month.
At this juncture, the
couple would have to decide should they continue with the same
line of work, change careers, or take some time off, since if
the couple are in their 40s or 50s, they will both be too young
to retire. They will, in all probability, have 40 to 50 years
left. Should they continue to work, they will easily enter the
ranks of multi-millionaires by just letting the 401(k) increase
over time, even without adding to it.
There is also a pragmatic
side to the formation of wealth. Whereas retirees generations
ago could count on living only a few years into retirement, increasingly,
more people are living into their 80s and 90s20 to 30 years past
the retirement age of 65. Few people have saved for a world where
they may use up their retirement funds before they expire. With
the possibility of inflation returning in the years ahead, the
longer the time to retirement, the more time the gnawing element
of inflation has a chance to eat away into the buying power of
conservative investments.
Today, 12 percent of people over 65 years of age are still in
the work force. This will dramatically change as the oldest baby
boomers begin reaching their mid-sixties by the year 2011. Financial
experts are predicting that increasingly older couples will be
unable to retire fully. Statistics provided by the U.S. Census
Bureau demonstrates this sad fact. Nearly 70 percent of Americans
age 65 and over find themselves with a household income of less
than $25,000 per year. Around 45 percent of Americans in this
group have a household income of less than $15,000 per year (and
most of this is the form of Social Security payments), just at
the poverty line for a family of four. By the year 2005, around
54 percent of the retirees will be in serious economic difficulty.
Many of these people may have had sizable incomes at one time
but built up meager nest eggs. Their failure to plan for their
financial future during their working years will come back to
haunt them.
Social Security has
been an important source of retirement funds for millions of
American families for more than sixty-five years. When first
conceived, it was intended as a supplement to individual retirement
savings and pension plans. Historically, it has accounted for
20-30 percent of the average, middle-income workers retirement.
For the future, however, it might be closer to 60 to 70 percent
for low-net-worth households.
A report issued by
the nonpartisan Congressional Budget Office on December 2, 1999
belies the much-touted claims by GOP congressional leaders and
President Clinton that the $17 billion budget surplus in 1999
would leave Social Security surpluses untouched. The Republican
promise to draft a budget that would safeguard Social Security
surpluses, for the first time in decades, and preserve the sanctity
of the Social Security funds for later years was pushed aside.
Earlier bipartisan promises made it seem the issue of Social
Security would be remembered as the last problem of the 20th
century. Now, it looks as if it might be recalled as the first
crisis of the 21st century. Like any other year in the past 60
plus years, other government programs and operations are again
partly financed by Social Security trust funds.
Without Congressional
reform, by 2034 the Social Security program will exhaust the
surplus now accumulating (and being spent on other government
programs), and annual payroll taxes will only be able to provide
75 percent of benefits. At the same time, the over 65 population
will grow from 34 million to 70 million peoplefrom 12 percent
of the population today to 20 percent. Retirement for the aging
baby boomers will be a bleak prospect indeed.
At the current rate
of wealth creation in America, by the year 2005, out of 100 workers
at age 65:
1 will be wealthy ($5 million net worth and up)
4 will be financially independent ($1 million to $4.9 million net worth)
41 will be working
54 will be dead broke
Which
category do you want to be part of?
A little determination,
discipline, and goal setting can set you on your way to $1 million
net worth and financial independence. With this information,
you, too, can be the millionaire next door.
Editors Note:
Excerpted from How to Become a Millionaire: A Straightforward
Approach to Accumulating Personal Wealth (Longstreet Press, Inc.
1999).
Mark Alch was born and raised in Minneapolis, Minnesota and attended
the University of Minnesota where he received his B.A. degree
in Political Science and M.A. in History. He received his Ph.D.
in History at UCLA. He has lived in Irvine, California with his
wife and two children for the past twenty-two years. Alch is
the author of How to Become a Millionaire: A Straightforward
Approach to Accumulating Wealth (Longstreet Press, Inc., 1999,
$20). Alch is an instructor in the Business Management Program
at the University of California, Irvine. He is also Executive
Director of Mark Alch & Associates whose core value is to
democratize financial planning through education, training, and
the dissemination of information for people from all levels of
income. Read his free "Newsletter on Wealth Creation"
at www.Markalch.com.
