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One Million Dollars

Once upon a time, when I was in college, I was having a discussion with a group of friends. I've long ago forgotten the overall discussion, but I do remember that during this conversation I had hastily and with no forethought set a personal goal to be a millionaire by the time I was 35 years old.

I started taking this goal more seriously when I realized it could play a role in my personal finance blogging. (I don't have any other handy numerically-oriented goals such as paying off my mortgage — I decided it's better to pay it slowly.) My preliminary numbers showed that the goal would be difficult but not impossible to reach. Perfect! That's exactly the sort of thing that extra focus and planning are needed for.

One million dollars!

Dr. Evil demanding one million dollars

If this article feels like it's stream-of-consciousness, that's because it is. I'm working on my spreadsheet as I write this.

There is some ambiguity in "millionaire by 35", so I've decided to clarify the goal to mean that my net worth should be at least $1 million prior to my 36th birthday, and that I should ignore deferred taxes on savings — that is, I'll use the ordinary value of my 401(k) without subtracting an estimate for the tax I'll eventually owe on it.

The Roth IRA contribution limit will rise from $4000 to $5000 in 2008, the 401(k) contribution limit will rise from $14000 to $15000 in 2006, and both will then begin adjusting for inflation in $500 increments. My employer is not planning to offer the Roth 401(k) in 2006, so I'll pessimistically assume it won't be available to me at all. Assuming 4% inflation, these are my contribution limit predictions:

YearRoth401(k)
2005$4000$14000
2006$4000$15000
2007$4000$15500
2008$5000$16000
2009$5000$16500
2010$5000$17500
2011$5500$18000
2012$5500$18500
2013$6000$19500
2014$6000$20500

I'll fully fund my Roth each year in January, and model my 401(k) contributions as equal monthly amounts. Instead of a 401(k) match, my employer contributes to a separate profit-sharing account. Because it's based on company profits, it's difficult to predict, but for simplicity's sake I'll make it a $6000 contribution each February.

I'll assume I stay in my current house and that it appreciates at a 4% simple interest rate (compounded monthly) and that I make minimum mortgage payments. I won't include my car in the figures at all. I'll assume investments earn 7%. I'm not going to try to model my earnings from credit card arbitrage because I don't believe the opportunities will persist much longer.

The "easy" part of the calculation is to estimate my home equity and retirement savings. The spreadsheet says that under these assumptions, by my 36th birthday I'll have $237,000 in home equity and $528,000 in retirement savings. So, to reach my $1 million goal, I'll need to hold $235,000 in ordinary (non-retirement) investments.

I'll assume a tax rate of 30% on taxable investments, because they'll be a mixture of capital gains and dividends (15% federal + 9% state = 24%) and interest (25% federal + 9% state = 34%). My spreadsheet tells me the savings I already have won't be sufficient — as expected — so now I need to calculate how much additional money I need to save in order to reach my goal, and determine whether or not I'll have enough income to make it.

<drum roll>…

The spreadsheet tells me that under my assumptions, I will need to save $659.39 each month, even after contributing to retirement savings, in order to reach my goal. I believe I can do that.

The rosy scenario, where I wouldn't need to save any additional money at all, would require my house to appreciate at 6% (instead of 4%) and investments to earn 8% (instead of 7%).

I created the spreadsheet with monthly entries, rather than annual entries, so that it would provide a series of target net worth values I can use to track progress toward my goal.

There are three main difficulties in applying the target net worth values I've just calculated. (1) They assume my house appreciates monthly, but the actual valuation I'll use for my house will only change annually when I get my property tax bill. (2) They omit the value of my car, so I'll need to note the discrepancy when I report each month. (3) Stock options are extremely volatile, so I don't expect it will be possible to track very closely to the goal figures.

The fact that I'm fully funding my Roth in January will not create a noticeable disturbance in my ability to track toward my goal, because January is also the month when my employer pays most of its bonuses. I will be approximately funding the Roth from income, rather than diverting from other savings.

My goal for my December report is $301,588.41, ex-autos. The goal is higher than you might expect from looking at my November report, but that's due to using a mid-month valuation of stock options that had a large appreciation.

Tiny Island