How to save a million bucks

Roger is the first to admit he’s no investing wizard. “I just figure if I throw enough stuff against the wall, some of it will stick.” What the Hunters have mastered is the art of saving. As soon as he started working full-time, Roger arranged automatic payroll deductions that, over the months, eventually bought him $10,000 worth of Canada Savings Bonds. Whenever his job required him to relocate, he took the moving allowance and put it in the bank. If he had a little extra cash, he called his bank and asked them to increase his mortgage payments.

Thanks to that attitude, the Hunters (whose names we’ve changed to protect their privacy) have saved more than $700,000 in their investment accounts. They paid off the mortgage on their $300,000 house in nine years, and own two rental properties, a tract of land and a motor home, with a combined value of more than $400,000. All this despite never earning a $100,000 income, until they hit that milestone last year.

When the Barenaked Ladies wrote their classic song about being rich, they didn’t call it “If I Had an Ample Nest Egg.” There’s no TV game show called “Who Wants Several Hundred Grand?” In the first Austin Powers movie, Dr. Evil didn’t obtain a nuclear warhead and hold the world ransom for 70% of his pre-retirement income. No, in our culture, the number that symbolizes real wealth is still a cool million. “I think I’ll need a million and a half to retire,” says Hunter. The couple is already there in terms of net worth, and they should have a seven-figure investment portfolio well before Roger hits 50.

At MoneySense, we’ve received many letters and emails from middle-class readers like the Hunters who have saved a million, so we thought we’d help you figure out if you could do it, too. We’re not going to pretend it’s easy—it requires a steady income, a commitment to saving, short-term sacrifices, and a smart investment strategy—but if Roger can do it, so can you. Joining the ranks of the millionaires may be a more realistic goal than you think.

Saving grace
The first secret to saving a million dollars isn’t a secret at all: spend less than you earn, then save and invest the difference. “That is so dirt simple,” says David Christianson, a financial planner and portfolio manager with Wellington West Total Wealth Management in Winnipeg. “But I work with people who have accumulated significant net worth, and most of them have accumulated it by using that formula.”

The percentage of your income you need to save depends on how much you earn, how many years you have before retirement, and what kind of return you expect on your investments. As a rule of thumb, Gail Vaz-Oxlade, financial author and host of ’Til Debt Do Us Part, says that people who start saving in their twenties can assure themselves a comfortable retirement by setting aside just 6% of their net (after-tax) income. For someone whose take-home pay is $50,000, that’s an RRSP contribution of about $250 a month.

If your heart is set on saving a million, however, you’ll likely have to sock away more: On the opposite page we’ve created a Model Millionaire and figured out how much he needs to save each year. We found that about 10% of his middle-class income should do it, if he wants to hit seven figures by age 65. That means in his thirties and forties, he’d have to save $300 to $500 a month. That’s a challenge for someone earning $50,000 or $60,000, paying off a house and raising children. But remember the part where we said this wasn’t going to be a breeze?

You can make it easier by setting up an automatic RRSP contribution on payday so you don’t have a chance to spend your savings. “Pay yourself first” has been a mantra for decades—because it works. Most people never get behind on their income taxes, mortgages or car loans because they never see the money earmarked for those purposes. Make your savings a fixed expense, too, and you’ll be well on your way to saving a million.

Living on less
When Thomas Stanley and William Danko wrote The Millionaire Next Door, they set out to examine the lifestyles of the wealthy. What they learned surprised them: the people who wore expensive suits, drove flashy cars and drank fine wine had high incomes, but they weren’t necessarily wealthy. Most of the millionaires they studied, by contrast, dressed casually, drove Chevrolets and drank Budweiser. The authors summed up their observation simply: “Wealth is what you accumulate, not what you spend.”

The lesson here is that if you want to become a millionaire without a huge income, you’re not going to look like a millionaire. The Hunters are perfect examples: Roger is pretty sure his soccer teammates have little idea what he’s worth. People who save 10% of their net income aren’t typically paying $800 a month to lease an SUV, nor are they eating in restaurants three times a week. They buy what they need, and they recognize good value, but they don’t indulge every desire. This frugality comes naturally to the Hunters, but there’s hope for anyone who is truly committed to their financial goals, says Vaz-Oxlade. “There is no question that some people are born savers. However, I have gotten too many letters from too many people who were spend-crazy and who have subsequently seen the light. It’s all about prioritizing.”

One of the biggest barriers to saving a million-dollar portfolio is the priority we put on our homes. According to RBC Economics Research, owning a two-storey home costs the average Canadian household more than 46% of their pre-tax income. If you’re pouring that much into your house for 25 years or more, your chance of saving a million is vanishingly small. The goal becomes realistic, however, if you buy a home you can afford to pay off in 15 years. Once the mortgage is gone, you can redirect the payments to your RRSP and see your portfolio suddenly jump to life. (We cost out this scenario in “The Late-Blooming Millionaire,” below.)

Get time on your side
There’s no question that starting early is a huge advantage. Any online savings calculator will show that you can save a million by tucking away just $500 a month if you have 40 years to do it (assuming a 6% return). Unfortunately, life isn’t as simple as a savings calculator. “Those linear graphs that show how to achieve $1 million don’t match the human life cycle,” says Neil Murphy, a financial planner with Weigh House Investment Services in Toronto. “Your cash flow doesn’t match that. The people who are aggressively saving are usually a bit older, their kids are gone, they’re hitting their stride income-wise and their expenses are going down. But I doubt that many of them were doing massive savings in their twenties.”

If you live below your means when you’re young, concentrating on paying down debt rather than buying expensive toys, you’ll likely have little trouble applying that same discipline to retirement savings as you get older. Once you’re mortgage-free and your kids have moved out, you may well be able to save 30% or 40% of your net income during the last 15 years of your working career. But if you’re spending more than you make and continually refinancing your home to bail you out, you’re not going to suddenly morph into a super saver at age 50.

The slow-and-steady road to a million puts compounding on your side, but it does have one psychological pitfall: the finish line can seem so far away. Our Model Millionaire on page 68 starts saving 10% of his net income at 25, and two decades later his nest egg has grown to just $212,000. He’s halfway through his 40-year savings plan, and yet and he’s barely a fifth of the way to his goal. That can be awfully discouraging if you don’t understand the nature of compounding: most of the benefit comes near the end. For instance, our investor’s portfolio took 20 years to grow from zero to $212,000, but it will double in just eight more years. By the time it reaches half a million at age 55, a 6% return will be spinning off $30,000 of growth annually. That’s more than our hard-working saver contributed during his first six years.

The tipping point comes when the dollar value of your portfolio’s annual return exceeds the amount you’re contributing. At 35 years old, three-fifths of our Model Millionaire’s portfolio growth comes from contributions. Just five years later, however, the portfolio has grown to more than $115,000 and everything has changed. His portfolio’s return is now adding more to his savings every year than his contributions. Once your portfolio is working harder than you are, your goal will feel a lot closer.

Keeping more for yourself
The final piece in your million-dollar puzzle is the right investment plan. It’s possible for extreme savers and top-tier earners to amass a fortune in savings accounts and GICs. But if you’re planning to hit seven digits by saving 10% of a modest income, you’re going to need help from the markets.

Your first step is to check your expectations: if your map to a million includes 8% or 9% returns every year, you’re likely to be disappointed. True, the markets have returned more than that historically: during the 25 years ending in 2007, even T-Bills averaged almost 7%, while bonds returned close to 11% and stocks almost 12%. But that included periods of double-digit inflation and steadily declining interest rates, two things we’re not likely to see in the decade ahead. Neil Murphy says that high costs and bad decisions—things like chasing hot funds or panicking during market crashes—doom most investors to subpar returns. When he makes projections for his clients, he uses a 5% to 6% expected return for a portfolio of half equities and half bonds.

One of the best ways to conquer the one-two punch of high fees and self-destructive behaviour is to adopt the Couch Potato investment strategy. Low-cost index funds or exchange-traded funds (ETFs) are the best way to capture your fair share of the returns the markets deliver. A Couch Potato portfolio can easily cost less than 0.5% a year in fees if you manage it yourself in a discount brokerage account.

Have no illusions here: fees can destroy your returns and easily derail your million-dollar journey. Canadians pay some of the highest investing costs in the world: annual fees of 2% to 3% aren’t unusual. If our Model Millionaire has his annualized return reduced from 6% to 4% because of mutual fund expenses or other fees, he’ll fall well short of his million-dollar goal with just $672,000. Ask yourself whether it makes sense to put up all of the capital and assume all of the risk, while reaping only two-thirds of the return. If you don’t end up being a millionaire, you can be sure your investment adviser will.

The million-dollar question
We hope we’ve shown you that saving a million bucks is a realistic goal for disciplined investors with a good (though not enormous) income, and several decades to make it happen. The question you need to ask yourself now is more introspective: is it worth it? Like any sacrifice, your long-term savings plan should be done with a higher purpose. Your ultimate goal, after all, is supposed to be happiness.

A funny thing can happen on the way to the Millionaire’s Club. People who spend their whole lives scrimping and saving suddenly find themselves having to draw down their portfolio when they retire, and it doesn’t come naturally. “I would bet that for 25% of our clients each year, our job is helping convince them that they can spend more money,” says Christianson. “People who are good at saving often have trouble letting go.”

Living frugally, paying off your debt and saving for retirement should be everyone’s financial goal. But if you’re turned off by the idea of scrimping for decades just so you can call yourself a millionaire, that’s fine. “Don’t start with the end result, start with the process,” says Vaz-Oxlade. “It’s less about a magic number and more about you deciding where you want to be, where you are now, and how you are going to close the gap.”

Now there’s advice that’s worth a million bucks.

The model millionaire

Like a robot programmed to save, you contribute 10% of your net (after tax) income to your RRSP fromage 25 until age 65, and you turbocharge your savings by reinvesting your RRSP tax refund every year. You’re comfortable with a balanced portfolio of stocks and bonds designed to achieve an annualized return of 6%.

The super-safe saver

You can’t get a return of 6% without risk. If you’re the ultraconservative type of sticks to GICs and other safe investments, you may have to save a quarter of your net income to retire a millionaire. Here we assume you’re maxing out your RRSP every year, so your annual contribution is 18% of earned income to a maximum of $22,000. (Since you’re using up all your RRSP contribution room, you can’t reinvest the tax refund.) We assume a low-risk annualized return of 3.5%