Most people still live from pay cheque to pay cheque, never actually saving anything. Other are trying to save $1000 this month and $1500 next month because they feel that is the only way they can save anything worthwhile. Before long though, they realise the pain of going without so many things in order to save so much money. So they connect pain and frustration with saving money, and quickly find an excuse to spend whatever they have saved up, on something that will make them feel better.
But what if it wasn’t so hard to save? What if all it took was sticking $10 a day away? Let’s first take a look at what $10 can buy, and realise how easy it is to do without $10.
- A meal at McDonalds
- 2 beers at the pub
- Half a CD
- Half an adult movie ticket at the cinema
- A cheap hair cut
- A return trip on the M2 Motorway
So as you can see, $10 really doesn’t get you very fair. As you are reading this, you have probably already realised there is no way that $10 a day will actually make a million dollars ($1,000,000). “It would take 100,000 days to get to a million dollars.” Yes, that’s right. If you put $10 away under the mattress or into a safe, every day, it would take 273 years before you became a millionaire.
Now, the average person will have a working life of only 40yrs. So let’s count:
- $10 a day 40yrs ($3650 x 40) = $146,000
Now you may be thinking; “Hang on, that’s nowhere near $1million.” and you’d be right. So this is the part where we get introduced to compound interest. Most of us have heard of “Interest”. Whether its the Reserve Bank keeping interest rates on hold or the bank giving you a 7% interest rate on your mortgage, most people have come across the term “Interest”.
OK let’s segway for minute, and quickly cover the concept of a savings account. When you have money you want to keep for the future, you can put it into an account with your bank for safe keeping. Now, in exchange for allowing the bank to use this money themselves to lend to other people, or trade on the overnight markets, they will pay YOU an interest rate on the amount you have saved. Now a standard savings account might have say 3.5% interest p.a. (a year or per annum). That means that if you put $1000 into a savings account, the bank will give you $35 extra to say thank you. “Haha, sweet. $35 and I didn’t do anything except keep my money safe. Foolish bank.”
Hang on a minute, before you get too excited, this 3.5% is an insult. “Why?” you ask, because the bank will be making AT LEAST double that using your money, more often 4 times or more. So, you don’t want a standard savings account. What other options are available to you? Another type of account is called a “Term Deposit”. These accounts will give you a much better interest rate, because you agree not to withdraw the money for a long time, typically at least 1yr. In these cases you might get, say 7% p.a. “Cool $70, and I didn’t do anything”
OK, so let’s say you put $10 a day into a term deposit account that gave you 7% interest rate, paid every year. So it would look something like this:
- $10 a day for 365 days($3,650) + 7%($255.50) = $3,905.50
“$255.50! Now we’re getting somewhere.” But hold on a minute, that is what you would get if you had $3,650 in the bank for the whole year, then the bank would pay you 7%. You were only putting in $10 a day (Day 1 = $20, Day 2 = $40, etc), so at the end of the first year what you would really have is: $3,778.10. But hey, $128.10 is still pretty decent. You didn’t even have to lift a finger.
So at the end of the first year you have $3,778.10. That’s $128.10 extra per year, plus the $3,650 (or $10 a day). But what does it look like over time?
- $3,778.10 per year, after 40yrs = $151,124
“OMG Woohoo, it only took 40yrs to make an extra $5,124. This is so stupid. You’re an idiot. You don’t know what you are talking about.” Ahhhh, but now I need to explain the concept of compounding.
Compounding is simply when something gets put on top of something that went before it. In this case, it’s called “Compound Interest”, and this is where the magic really starts to happen. Compound interest means you are getting interest, on top of the interest you were already paid. “Wait…what?” That’s right, you will get paid for interest on the interest you already got paid. Let’s look at it a little closer.
So at the end of the first year you had $3,778.10, made up of what you put into the account (called the principal) and what the bank paid you for being allowed to use it (called the interest). So in the second year you put another $3,650 ($10 a day) into the account and they pay you again. So this time it’s 2 years of your money, plus 1 year of their money. At the end of the second year, you will have: $7,820.31. Now if we simply took what you had at the end of the first, and multiplied it by 2yrs, you would have $7,556.20. So you actually got $264.10 more than you thought. In fact the total interest you received so far is $520.31 ($128.10 in the first year, and $392.21 in the second year). That’s more than 3 times the interest from before. So after just 2yrs, you have an extra $520.31 for doing sweet nothing. All you had to do was keep popping that $10 a day into your account.
By now you are probably starting to see the picture. If it was $128 in the first year, and $392 in the second year, what about the third year, or the fifth, or the 10th. Rather than explain it in words, I thought I would let the numbers do the talking. Below you can see the amount you have invested plus interest you have earned at the end of various years, going out until you reach $1,000,000.
- Year 1 – $3,778.10
- Year 2 – $7,820.31
- Year 3 – $12,144.79
- Year 4 – $16,771.27
- Year 5 – $21,720.91
- Year 10 – $52,165.95
- Year 15 – $94,846.56
- Year 20 – $154,688.19
- Year 25 – $238,599.05
- Year 30 – $356,268.25
- Year 35 – $521,285.25
- Year 40 – $752,710.01
- Year 44 – $1,003,296.67
Congratulations. You did it. And all it took, was putting $10 a day, into a bank account, and then going on about your daily life. You actually only saved $160,610. The bank paid you more than $921,000. No stress and no worries about retirement.
So…..are you sure you can’t find $10 a day to save. If you do, you will retire a millionaire.
Stay tuned for the next article, where I will show you how to do it 10.5 years faster.