A million dollars isn’t what it used to be.
We’ve all heard this and intuitively understand it. We know that inflation means you probably paid more for your last car than your grandparents paid for their first house.
Heck, you’ve probably seen the results of inflation in your own lifetime. Remember when people would look at you funny if you spent more than $5 for lunch. Now it’s impressive to spend less than $10 and a heroic feat of frugality to spend less than $5.
Any historical marker of wealth is obviously diluted in an environment where everything costs more.
But millionaire status is still held up as a major indicator of wealth. It’s still something that people aspire too. Titles like The Millionaire Next Door still get people’s attention.
So let’s ask the question, is millionaire status still meaningful in 2021 and beyond? We’ll start with two reasons why it’s overrated, then pivot by making two points that defend millionaire status as being a worthwhile goal.
A Million Dollars Doesn’t Go Very Far
For some people, the dream is to become so rich that they can spend lavishly and still never worry about running out of money.
A million dollars will absolutely fall short of fulfilling this lofty fantasy.
Let’s crunch some simple numbers. First, let’s assume you need the money to last 20 years. This is a pretty simple calculation, just divide $1,000,000 by 20 and you get $50,000.
So with a million dollars, you can spend $50,000 a year and run out of money in 20 years.
So let me ask you a couple of questions:
- Does spending $50,000 a year sound like extravagant wealth?
- Does completely running out of money in 20 years sound like extravagant wealth?
It Was Hard to Spend a Million Dollars 100 Years Ago
I recently stumbled across a fascinating article from U.S. News that explored the prices of various things from 1915.
It’s pretty clear that a million dollars would go very far back then.
Consider this table of a few items you might buy at the grocery store:
|A loaf of bread||$0.07|
|A dozen eggs||$0.34|
|A quart of milk||$0.09|
|A pound of steak||$0.26|
You could go to the store, come away will all that, and still have nearly a quarter in change. That’s unbelievable.
Apparently in the Kentucky newspaper the Louisville Courier-Journal, a woman named Louise Johnson wrote that you should keep your rent below $25 a month. If that isn’t crazy enough, she was including the cost of commuting in with your rent.
Again, let’s do some simple math. If you have a million dollars and rent is $25, you can pay rent for 40,000 months (1,000,000/25). Divide that by 12, and you realize that a million dollars was enough to pay rent for 3,333 years.
Of course, that would be spending all your money on rent. Let’s say you take Louise Johnson’s advice and spend 20% ($200,000) on rent. You could pay rent for 8,000 months, almost 667 years, and still have 80% of your money left to spend on other things.
No wonder a million dollars was once seen as a virtually limitless amount of money.
A Cash Poor Millionaire
The thing about millionaire status is that it’s dependent on your net worth, not how much money you have in the bank.
The simple way of thinking of your net worth is that it’s what you own minus what you owe.
Add up all your assets such as bank accounts, investment accounts, your house, etc., and subtract your liabilities (debt) and that’s your net worth.
Your net worth is a good snapshot of your financial health. It’s a decent answer to the question of what do you have to show for all the money you’ve earned in your life. Tracking your net worth over time can help you see if you’re making progress.
But your net worth doesn’t represent how much money you have to spend.
Having a million dollars in your checking account is one thing. Having a net worth of a million dollars is something else.
While having a high net worth is better than having a low net worth, it’s possible to have a high net worth and feel trapped financially.
This often happens when your home equity represents a large portion of your net worth. By home equity I just mean how much your house is worth minus how much is left on your mortgage.
Let’s say you bought a house for $500,000, and it has doubled in value to $1,000,000. By the way, at the time I’m writing this, this isn’t some crazy hypothetical. Most of the people who bought 5-10 years ago have seen their home values double.
So on paper, you’re almost a millionaire. If you have no other debt and the rest of your assets are worth more than what’s left on your mortgage, you are a millionaire.
But chances are you don’t feel very wealthy.
Yes, you have an impressive amount of home equity, but how can you take advantage of it? If you sell, where will you live? You could take out a home equity loan if you need some cash, but you’ll have to pay it back with interest.
While your house counts towards your net worth, it’s not a liquid source of capital. You can’t effectively leverage it to buy the things you want to buy.
This is the home ownership liquidity trap. Your net worth looks good, but you’re stuck working a job you hate to make payments on a bloated mortgage. And that’s no fun. There’s even a term for it: House poor.
Of course, the term really should be “cash poor,” but “house poor” has a certain ring to it.
A Million Dollars is Still Better Than Most
Ultimately, wealth is relative.
I often point out that people in nice apartments think that homeowners are rich. Homeowners think that mansion dwellers are rich. Mansion dwellers think that pro athletes are rich. Pro athletes think that Oprah is rich.
And I really hope Oprah knows that she’s rich.
According to an online net worth calculator I found, having a net worth of a million dollars put’s you in the 88th percentile. With a net worth of $1M or more, you’re better off than 88% of Americans.
If you’ve amassed a million dollars outside of your home equity, you’re in the 90.5 percentile.
The median household net worth is 2020 was $121,411. So if you’re a millionaire, not only are you wealthier than the vast majority of people, but you have more than 8x the net worth of the typical person.
A Million Dollars Can Buy Your Freedom
Even though wealth is relative, we can find a few objective measures.
Probably the most important measure is that of freedom. Do you have enough money to never need to work again? Can someone tell you that you need to be at a certain place at a certain time? Are you a slave to a cubicle? Or do you call the shots?
Unlike the dreams of wild spending without fearing the consequences, buying your freedom almost certainly means that you’ll need to be disciplined enough to live a frugal lifestyle.
If you can live within a certain budget, then all you need to win your freedom is enough money to fund that lifestyle with passive income.
It’s impossible to say exactly how much this is, but a good rule of thumb is the 4% rule. Basically, it says that when you retire, you can take out 4% of your portfolio to live off of this year, adjust future withdrawals for inflation, and have a really good chance of your portfolio surviving. In fact, chances are that your portfolio will grow.
So yo can figure out how much you need to never work again by dividing your annual spending by 0.04.
Or, we can figure out how much income a million dollars will generate by multiplying it by 0.04. Under the 4% rule of thumb, a million dollar portfolio will spit out $40,000 a year in passive income which can be adjusted up for inflation.
I know earlier that I said that spending $50,000 a year probably doesn’t sound like your idea of wealth, but this is a different kind of wealth.
One way of measuring wealth is by the number of things you are able to buy. Another way to measure it is by the amount of time you can free up. And freeing yourself from the rat race absolutely constitutes living a rich life.
A million dollars clearly isn’t what it used to be.
If you have a fantasy of limitless spending, you are in dire need of finding a higher level of wealth to shoot for.
But a million dollars is still more than most people have. And for the frugal person, it can buy something priceless: Freedom.
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