A few years ago two elderly California ladies concocted a brutal and dastardly scheme to make $2.8 million. Their plan involved life insurance fraud and homicide. They implemented the scheme over a period of years in the belief that a statute of limitations would prevent the insurance companies from contesting the fraud.
Since this is a family site I’m not going to dwell on the details of the scheme. If you’d like to satisfy morbid curiosity you can read the article (link above).
Now the 77-year-old woman is in for life without the possibility of parole. Her 75-year-old co-conspirator faces 25 years to life. Prosecutors are not seeking the death penalty because both women will have died of natural causes long before the legal system could impose the death penalty.
A Better Way to Make $2.8 Million by Age 77
Fortunately there are better, legal ways to make $2.8 million by age 77. Let me illustrate what I believe is the easiest for the greatest number of people.
When you are 27 years old you commit to putting $243 per month in a brokerage account. You invest your money in a diversified portfolio of low-expense funds with low dividend yields to minimize current tax liabilities. You achieve an annual before-tax return of 10%. You invest relatively tax efficiently.
By age 77 you have a portfolio worth nearly $3.7 million. You sell everything, pay federal and state income taxes at capital gains rates (I’m assuming today’s capital gains tax rates for someone in California), and you have $2.8 million left.
Hmmm…. $243 per month sounds easier than insurance fraud and murder. It takes 50 years of commitment, but the commitment is not very burdensome (only $243 per month) and doesn’t take a lot of time once you get the hang of it (passive index investing).
Inflation Hurts You….
Of course $2.8 million will not be worth as much in 50 years. At 3.5% annual inflation it will be worth only $500,000 in today’s dollars. How much more do you need to invest each month to overcome the effects of inflation?
The answer is rather sobering. You would need to invest $1,360 per month to end up with $21 million before tax. You would pay over $5 million in tax when you sell everything at age 77, leaving you $15.6 million. After compensating for inflation, your $15.6 million is worth $2.8 million.
Yikes. $1,360 per month is a lot harder than $243.
I’ve got three tricks up my sleeve to make things easier. The first involves inflation.
And Inflation Helps You
While inflation hurts you by making your money worth less, there is a beneficial flip side to inflation. Assuming your wages or other earnings keep up with inflation (and they should), you will be able to increase your annual contributions to your brokerage account by 3.5% without any real sacrifice on your part.
Once this “beneficial” side of inflation is taken into account, you only need to invest $982 per month in the first year, and thereafter increase the amount by 3.5% each year. After paying taxes you will end up with $15.6 million in the year 2058, which will be worth $2.8 million in today’s dollars.
If you increase your annual contributions by more than the rate of inflation, natually you will end up with more than $2.8 million. Alternatively you could start with a lower monthly amount at age 27 and still arrive at $2.8 million by age 77.
Tax Efficient Investing
Trick number two involves tax efficient investing.
All scenarios above assume relatively tax efficient investing. How much better does it get with really tax efficient investing? It is possible to invest in a way that maintains the same 10% annual return while incurring the additional tax benefit of an annual $3,000 capital loss. The capital loss can be deducted against other income to reduce your tax liability.
Why do I choose $3,000? Because that’s the annual limit on the amount of capital loss you are allowed to deduct against other income. Anything over $3,000 must be carried forward to future years.
The amount of savings achieved through the capital loss depends on your tax rate. The greater your tax rate, the greater the savings.
Assuming a federal tax rate of 25% and a state tax rate of 9.3% (California), tax efficient investing lowers the amount you need to invest per month to $927 during the first year (increasing by 3.5% per year). It’s a slight improvement over the $982 that was required with the moderately tax efficient investing.
Increase Your Annual Return by 1%
Trick number three, the best trick of all, requires you to increase your annual return from 10% to 11%. This can be accomplished through several methods, most (all?) of which require you to slightly increase your risk exposure.
Why did I choose 10% to start with? It’s a reasonable estimate of the historical long-term return of the S&P500. A truly diversified portfolio would include medium and smaller companies, foreign developed and emerging markets, real estate, etc. If history continues to repeat itself, a truly diversified portfolio that includes these other asset classes should achieve a return greater than 10%. And of course there are other ways to increase your return (will be the subject of other posts). However, I’m going to stick with 10% as a base value, and increase it to 11% to illustrate the power of squeezing an extra percentage point from your investments.
Taking into account all the tricks laid out above (11% annual return, really tax efficient investing, and increasing contributions to your brokerage account by 3.5% annually), you only need to invest $631 per month. You’ll end up with over $21 million before tax in 50 years, $15.6 million after tax, or $2.8 million in today’s dollars.
In case you’re curious, if you can increase your annual return to 13% (not unreasonable), you only need to invest $280 per month to hit $2.8 million at age 77. Increasing annual return by just a percent or two is very powerful when propagated over a long period of time.
Conclusion
I’ve laid out two ways for all you 27-year-olds to have $2.8 million at age 77. One requires you to spend your retirement committing crimes punishable by death.
The other requires you to start now, learn how to invest your money, and make a 50 year commitment to investing wisely and tax efficiently. Because of the long investing horizon, there’s a high likelihood of success.
If you’re over 27 you need to do a little more: higher monthly contributions to your brokerage account, higher return, better tax efficiency, or lower inflation.
The first three are doable.
The last one is tougher because it requires you to become an economist and get appointed Chairman of the U.S. Federal Reserve.
At least you won’t spend your “golden” years behind bars.