Who Wants to Be A Millionaire?

Road to Millions | 24. Aug, 2011 by AffordAnything.org | 32 Comments

The other day I mused about how to be a millionaire, but today I’m reeling the conversation one step back: SHOULD you want to be a millionaire?

Many people think you shouldn’t. Many say chasing a million dollars won’t make you wealthy.

The problem is that $1 million is an arbitrary figure, plucked from thin air.

What’s so magical about $1 million dollars? Will it buy a sprawling mansion in the Hollywood Hills? (Nope). Will it promise financial security? (Nope). Will our lives change between the day we have $950,000 and the day we cross the $1 million mark? (Probably not.)

Many people believe that instead of chasing $1 million dollars, you should focus on chasing “passive income” – a term that means “money you get while sitting on your butt.”

I (sort of) disagree. Passive income IS the ultimate goal, but aspiring to be a millionaire can get you there. Follow my logic here …

Motivate Me to $1 Million …

Passive income, for those of you who have never heard that term, is money that you make without lifting a finger. It could be money your investments earn, or money rolling in from royalties, or rental income on a house that you’re hired someone else to manage.

Passive income is the true yardstick of wealth. Once you earn enough passive income to pay your bills, you’re financially “free.” You’ll never have to work again unless you want to.

But it can be tough to calculate exactly how much you’ll need in order to reach financial freedom. All of those calculations are built on assumptions – how much will the stock market return? How long will my rental property sit vacant?

Once you calculate a number, it’ll most likely be an odd figure: $1,147,807 for some people, or $987,243 for others.

Psychologically, it’s tough to get pumped for a savings goal of $987,000 or $1.14 million.

Imagine that your goal is to watch your brokerage account cross from five digits to six. You’ve got $99,600 in investments. You need only $400 more until you hit six figures. You’ll be pumped to earn and save that cash. Who wouldn’t?

Now imagine that your goal is to have $94,000 in your account, and you currently have $93,600. You’ll need to earn and save the same $400 to achieve your goal, but your motivation won’t be as strong. The “reward feeling” just won’t be the same.

The brain responds to symbolic hallmarks. That’s why dropping from a weight of 201 pounds to 199 pounds feels like a large victory (no pun intended). That’s why improving your grades from B+ to A- feels like a huge boost.

In reality, you’ve only lost 2 pounds in weight or gained 2 points in your test scores. But the feeling of victory makes those 2 pounds, or those 2 test score points, a cause for celebration.

And that feeling is ultimately what keeps you motivated.

So maybe I’ll only need $987,000 to create enough passive income to pay my bills. Maybe I’ll need $1.14 million, or $1.23 million, or $1.76 million. But none of those numbers are going to motivate me.

You know what will motivate me? Watching my brokerage account cross from six digits to seven.

Isn’t Passive Income Enough of a Goal?

Some might argue that you could motivate yourself through a goal of hitting a ‘passive income’ hallmark – say, $40,000 a year in passive income.

The problem is that this is a secondary goal. To achieve it, you need to take an immediate action and then wait for a long-term result.

Let’s say you currently make $19,800 in passive income and your goal is to make $20,000. First, you’ll have to crunch some numbers (translation: guess) to figure out how much you’d need to save to create that extra $200 in passive income. Then you’ll need to contribute that guessed-number into your investment account. Then you’ll be forced to wait and see whether or not you’ll reap the predicted consequence.

This guesswork and “lag time” is a de-motivator. It’s better when your motivation comes from the immediate, tangible action itself.

That’s why wanting to feel energized (immediate) or lose weight (moderately immediate) are more motivating reasons to exercise than wanting to reduce the number of days you feel sick next winter (long-term result).

What Can $1 Million Buy?

Okay, so let’s imagine that you ultimately want passive income, but you decide to set a goal of investing $1 million dollars. What will that yield you?

For the sake of example, let’s look at the real-life numbers of Vanguard’s Dividend Growth Fund (VDIGX).

You invest $1 million into this fund. You live on the dividends, which average 3 percent each year, or $30,000 dollars. This is your “passive income.”

Although you’re living on the dividends, you’re reinvesting the gains. This fund grew at a yearly average of 7 percent since 1992 – some years less, some years more. Of course, most of that growth happened in the 1990’s, when the markets were on a winning streak. In the past 10 years, it only returned a 4 percent average.

Let’s look at the worst-case scenario: You invested your $1 million in summer 2001, just before the Sept. 11 terrorist attacks, the dot-com burst, and the subsequent stock market crash. By 2003, your $1 million dwindled to $640,000.

But don’t worry: your money more than doubled during the next 4 years. Then it crashed in 2007-08, losing half its value. Then it doubled again in 2009-10. It’s been a bumpy ride.

The $1 million you invested at the start of the worst decade since the Great Depression would be worth $1.4 million today. This outpaces inflation, which was about 2.3 percent over the past decade ($1 million a decade ago is $1.23 million today).

That $1.4 million in your fund today, earning 3 percent dividends, now gives you $42,000 in passive income – a nice “raise” you earn for doing nothing.

Of course, this balances out the “lean years” when your investments tanked and your dividends earned only $19,200. You budget for $30,000 a year and you save any “raises” to cushion the lean years.

I’m getting a little too mired in the numbers here, so let’s pull back and make the broader point: it’s easier to motivate yourself to create $1 million than to create passive income. And the result will be the same: Hitting a $1 million goal can produce the passive income that ultimately sets you financially free.

Speaking of being motivated by a symbolic hallmark: I have 97 Facebook “Likes”. Please help me hit 101 today!