I saw an interesting article on the Motley Fool this morning titled How to Turn $1,000 Into $1,000,000 (NOTE: I linked to the article but be warned that it is basically an advertisement for one of their subscription newsletters). The article got me to thinking about the rates of return that would be required to grow $1,000 to $1,000,000.
Of course the answer depends on how long you have to reach your goal. If your goal is to turn $1,000 into $1 million in one year, you have to get a 99,900% return. If you can wait two years, your required rate of return (ROR) drops to 3,062.28% per year. If your time horizon expands to a career of 40 years, your annual required ROR drops 18.85%, which is still very high considering the S&P 500 Index historically returned an average of about 10.4%. I put together a handy little graphic to show you the various required RORs to turn $1,000 into $1 million based on the number of years you have to reach your goal.
Now, what happens if you add $1,000 each year? As you can probably guess your required ROR drops. How much does it drop? Well, as the next graphic shows it drops pretty significantly the longer your time horizon (ah, the lovely power of compounding!).
Over a 40 year career, the required ROR to turn an initial investment of $1,000 into $1,000,000 by adding $1,000 per year is a much more manageable 12.17% (though this is still high when compared to the S&P 500 Index’s historical return). This just shows how important TIME is in the equation. The more TIME you have, the less you have to save in order to reach your goal.
Don’t Forget About Inflation
One thing that bugged me about the Fool article is this subheading for one of the sections:
Retire comfortably: $1 million in 45 years
I hate to be the one to ruin the party, but a $1 million retirement account 45 years from now is hardly what I would consider “comfortable.” Sure, $1 million has a nice ring to it but in 45 years it will only have the purchasing power of about $254,000 (assuming a 3% inflation rate over 45 years). Looking at it another way, a person would need $3.7 million in 45 years to equal the purchasing power of $1 million today. OUCH!
Bottom line: You’re gonna have to save more than $1,000!