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“How much interest do you earn on one million dollars?“
This was the question that Clint at Accumulating Money asked in a ‘classic’ post - I commented on it earlier this year and still receive click-through’s two or three months later. It must be a very popular question!
I’m not sure why, because it implies that people are happy to just have their life savings ’sit’ in CD’s …
… but, here’s the answer to the “million dollar” question courtesty of Accumulating Money anyway:
So, to answer the question, how much interest do you earn on One Million Dollars (assuming a 4% interest rate, compounded monthly)?
One Day - $109.59
One Month - $3,333.33
One Year - $40,741.54
Five Years - $220,996.59
Ten Years - $490,832.68
Twenty Years - $1,222,582.09
I think this related question asked by Afroblanco at Ask Metafilter - repeated on Get Rich Slowly (which is where I picked it up) - really goes to show how The Savers (as opposed to The Investors) think:
“What’s the safest possible thing that I can do with my money?” :
I take bearishness to an extreme. Having witnessed the 2000 tech crash, I have no faith in the stock market or the US economy. I keep all of my money (USD) in a savings account. However, with the recent financial turmoil, I have a few questions:
- Is it conceivable for the FDIC to fail?
- If so, is there a place where I can put my money that will be safer than a savings account?
- What’s the safest, most risk-free way for me to save money and not get killed by inflation and the tanking US dollar?
- If there is a safe way for me to save money and not be punished by inflation and the depreciating dollar, is there a way that I can do this without having to stress out and micromanage my finances? I don’t want to be checking the finance page and making adjustments every day.
Even though I follow finance news, I’ve never done any investing or money management other than socking money away in my savings account. I’m a n00b, I admit it.
OK … I confess …. I am like our friend, Afroblanco … very risk-averse; yet I have become rich by understanding that it is actually safer to invest than not.
The GREATEST RISK that our friend can take is NOT TO INVEST … inflation will just eat up any bank deposit/CD strategy.
Take Accumulating Money’s example above:
One million dollars approximately doubles in 20 years … but, inflation will halve its buying power!
Think about it, if the average bank interest rate is 4% (pushing the value of your savings UP) and inflation averages 4% (pushing the buying power or value of your savings DOWN), what have you gained in 20 years?
Nothing …
Now, if you just push your savings into a low cost Index Fund that averages, say, an 8% return over the 20 years, then the same 4% inflation means that you should effectively DOUBLE the value (or ‘buying power’) of your million dollars over 20 years.
But, Afroblanco is even better off BUYING The Bank [i.e. investing in the Bank's stock] than putting his money in The Bank. The risk of failure is about the same (if the bank fails you will lose the money that you have IN the bank’s vault as well as the money IN the bank’s stock), yet, as long as he has a long-term view (minimum 20 to 30 years), the former strategy will make him rich and the latter broke.
If the bank stock averages just 12% average growth over 20 years - as any well-picked Value Stock, can easily do - then Afroblanco won’t just double the buying power of his money ONCE, he will get to double it TWICE … that’s $4 million AFTER the effect of inflation (or, the $1 million grows to $10 million in ‘raw’ dollars).
What about risk? Aren’t bank deposits FDIC Insured?
[AJC: Well, yeah ... up to a paltry $100k - of course, you could open up 4 bank accounts at 4 different banks ... but, $400k is hardly what I hope my readers are aiming at!]
But, inflation is a much bigger risk: 100% certain to eat up your money … and, would the Federal Government (the same entity backing the FDIC) allow a Major US Retail Bank to fail?
I guess we’ll find out in the next few months!
If you don’t believe that’s likely, then isn’t your money just as safe in The Bank as it is in the bank?
[AJC: think about it 
]
And, doesn’t The Bank’s stock at least meet the overall market returns which averaged 8% p.a. for the past 100 years … what have bank deposits averaged in that time? 3%? 5%?
The point here is not necessarily to buy stock in The Bank … rather it’s to think about Investing rather than Saving …
Before suggesting WHAT to invest in, we need to know HOW long is our friend is expecting his money to last? Assuming that our friend is a hands-off investor, here’s what I suggest as the lowest-risk strategies possible:
If less than 30 years, then TIPS are a an option - PROVIDED that he can live off the inflation-adjusted interest (unfortunately, very unlikely in the current low interest environment - but, in 5/10 years, who knows?).
If 30 years or more, then a low-cost Index Fund is ideal for a hands-off investor. There has been NO 30 year period since the recording of the stock market indices where the market has not produced a positive return well above inflation.
If he is more hands on and/or more knowledgeable, then I would recommend no more than 4 or 5 well-selected individual stocks and direct investment in real-estate, for any time period 10 years or greater.
Inflation forces us to invest … because of this, inflation is our friend!
OK, define “direct investments in real estate”
I’m especially interestd in how you handle the day-to-day management of your real estate investments.
And what that costs you in terms of time & money.
@ Bill - If you have a ‘controlling interest’ in something then you are said to be a ‘direct investor’:
http://www.allbusiness.com/glossaries/direct-investment/4953241-1.html
On the other hand, an example of an indirect investment in real-estate would be through a REIT, a managed partnership (where you are just one of many financial investors, etc.).
I don’t see much difference b/w the two in terms of time etc. - in fact, all of my current investments are overseas (some real-estate; a couple of businesses; etc.) and are all managed for me by realtors, acountants etc. I delegate the day-to-day stuff and just get involved in critical descisions … that way I get to spend more time either building my portfolio or in leisure/family activities. Costs are per-hour (about $90k / year retainer for my accountant) and % of rent (6%) for real-estate.
Didn’t cross my mind to invest in real estate.
The interest calculation part is interesting though…
Most of what I’ll be considering are short term gains.
(Less than 5 years)
@ Warren - Don’t write off the long-term … reinvest a high proportion (at least 50% of your short-term gains) into long-term passive investments.
AJC.
PS sorry, but had to ‘chop’ your download link … it’s against WordPress.com’s rules to link to ’sales’ sites. Good luck with it, though!
“There has been NO 30 year period since the recording of the stock market indices where the market has not produced a positive return well above inflation.”
.
Questions:
1) what is your source for the above quote?
2) does the claim include dividends reinvested into the market index?
3) do you think that the probability of the claim holding in future is affected by investors who operate on the belief that it *will* so hold?
Thanks for this post, I’ve also been losing faith in the American stock market and have been wondering how best to protect myself against large-scale business failures. The FDIC is entirely inadequate, while stocking up on gold and silver seems a little too far.
You’ve given me some good ideas. I don’t want money just to sit around and be devalued due to inflation, but watching it get wiped out quickly in a stock crash is even less inviting.
@ Fish - Thanks.
@Julian - Thanks for your questions! In fact: “There has never been a thirty-year period in which you would have earned less than 8.5% in large company stocks”.
Now, for your answers:
1. There are many; here is one: “Plan Right for Retirement using the Grangaard Strategy” by Paul Grangaard. A great book on bond-laddering, by the way.
2. Yes.
3. No. Short-term fluctuations are based upon investor sentiment; long-term is simply based on the fact that 500 large companies (in the case of the S&P 500) will continue to make and sell good products at a profit … when you invest in stocks for the long-term, you are doing what Warren Buffett does: buying future cash-flows at today’s (hopefully bargain!) prices.
As someone who had money in NetBank when it went under in Sept 07 and who got reimbursed by the FDIC, I have to say it works pretty much exactly like it’s supposed to. The FDIC closed the bank on Friday afternoon, and it reopened Monday with new owners and FDIC cash.
NetBank had 2.3 billion in customer deposits so it wasn’t exactly tiny. So if you’re going to keep a million dollars in CDs, keep it spread out at different banks so you stay under the FDIC limit.
@ EA - As for leaving your money in the bank; yes choose a FDIC-insured one and spread your money to avoid the deposit limits that the FDIC will insure. You were lucky!
As for BUYING the bank [stock] … choose a bank like CitiBank that the Fed’s will prop up again and again (really!).
How can I get more than 16% of interest every years??
@ JC - You can’t … there’s a book called 80 Ways to Become a Millionaire or suchlike, where the author claims to have earned at least 15% compunded for the last 50 years. Balderdash … he would be Warren Buffett Jr by now. Also, some of the methods that he recommends are speculation, not investments and I will do an ‘expose’ on this book, soon.
Not suggesting that you SHOULD look for 15%-16% returns, but if you are, your best chance is to do what Warren Buffett himself does: buy some stocks in 4 or 5 undervalued companies and don’t sell & reinvest all dividends … you should be able to compound at 15% over a 20 or 30 year period.
I’ll take gold any day.
@ 9lb - Amen, Brother … just make sure you get yourself a good donkey, and a couple of strong saddlebags, to help you carry all them thar gold nuggets around … yee hah!
Almost no one considers the impact of taxes when calculating the income generated from a million dollars. Shortly, when democrats are in charge of the legislative and executive branches I expect you’ll find that the % due on income from investments of all sorts will likely increase– along with taxes on all sorts of other things — and therefore significantly impact the amount of money one can expect to realize from a $1,000,000 investment. You also need to consider whether the returns listed are net of broker/handling fees and expenses or not? Sometimes a stated return of 4 or 5% is significantly less. And that’s before taxes. So between taxes, inflation and brokerage fees, anyone planning on living on the 4 to 5% return on their $1,000,000 savings should — at the least– be aware of a realistic return.
@ Wise words from Wallflower. Thanks!