It is a common cliche, the first million is the hardest. In fact you also hear it as the first $100,000 is the hardest. But is their any truth in this common saying? Is the first net worth dollar figure harder than multiples of that number.
Well first there is the obvious. If you are talking about mathematically then the first million is definitely harder than the second. When you have 0 dollars the only contributor to getting to a million dollars is your savings. But when you have one million dollars you have the power of compounded interest working along with your savings to hit your next million.
No matter where you invest money it typically earns some sort of interest. Let’s say you chose to invest in the S&P 500. Since 1950 the S&P gas retired an annualized return of 7.42%. Now the thing to remember is during the first year you earn 7.42% adjusted for inflation on your million. The second year you earn 7.42% on the million plus the prior years 7.42%. In practice that means your returns compound. Each years earnings builds on each other to raise at an ever increasing actual dollar rate.
The Rule of 72
The rule of 72 is a mathematical concept that states you can determine how quickly compounding will cause a value to double by dividing it’s annualized percent return into 72. So in the case of our S&P annualized 7.42% we would expect our million to double adjusted for inflation in less than ten average years. So in the average 10 years your million dollars will become two million real dollars with no additional savings needed. Now nothing in life is guaranteed of course, risk in the market still exists, but lets assume for a moment that things our average over the next ten years. In addition to any savings you add each year you now have a significant helper in the form of interest.
Money begets Money
This leads me to the first lesson I ever learned about money: Money begets Money. Long before I practiced or even understood frugality I came to the realization that having money is the easiest path to more money. I actually realized this in high school and during that period it led me to focus on increasing my income earning potential. Here we are almost 2 decades later and it has paid dividends (sic). Thankfully, I picked up cost control somewhere along the way which has allowed our personal net worth to take off.
The thing is the first million is not only the most difficult because of math. It is also more difficult because of psychology. The first of anything represents something still to be achieved. Especially with a large number like a million that will likely take years to achieve it is easy to stray from the path. This is why I espouse smaller goals so often. If your only goal is to be a millionaire you will likely fail. Why? Because after the first 5 year pass and you still have less than 500K, with no other goals, odds are you will probably quit. After you achieve your first of something you have a notch on your belt showing to yourself it is doable. So psychologically the second million is easier as you already have a win.
Compounding and Psychology
Compounding itself also adds to the psychological easing of the second million over the first. That assist I mentioned earlier means things move more quickly, shortening the time between goal attainment. As numerous studies have shown quicker goal attainment can lead to a psychological boost that keeps you motivated. These two items combined likely go a long way psychologically to making the second million easier.
Psychology and Lower Savings Rates
Furthermore, the leg up can allow you to be a bit less drastic with your savings rate if so desired. I am not saying you should let life style inflation go out of control, but once you reach a certain level it is easier to get to the next. As such should you choose to do so, within reason you can loosen the reigns a bit as compounding can take up the slack. For those who might need a change or a mid life crisis that might not be a bad thing. After all, life is about the journey, not the destination. Financial independence is ultimately important, but you need to ensure you enjoy each day as you step towards that goal. So if you were depriving yourself at all during the first million, during the second you have even more reason to remove that deprivation as growing your net worth is now easier. An easier life likely means an easier path to the second million.
Financial Security and Risk
Finally, while a million may not be enough for financial independence for many, it should be enough for increased financial security. Financial security increases your ability and willingness to take risks <link>. If you can support yourself for multiples of ten years then you are in an entirely different situation then a person who is living pay check to paycheck. You can choose to take reasonable risks that may lead to a better lifestyle <link> or even more goal attainment. Even if you do not take advantage of slightly riskier options, not worrying about those risks (or worrying less) should mean that the next million will be easier on you then the first million. At a minimum you’ll be worried about things like job loss less. These are things that make the road to the first million less enjoyable.
In Closing, “One Million Dollars”
I wrote this for two reasons. One I was thinking about the math and psychology of goal attainment. But a secondary and perhaps larger reason was in response to those that might think it’s no big deal to hit a million in net worth. Externally it is no big deal, after all no one cares about your numbers except you. However, from an internal perspective it can perhaps mean a very big deal to your life and your future wealth progression. Now one could argue that the value one million is largely arbitrary and my rationale could also apply to 999K and 990K. You would be right. So take this as more a post about the general vicinity of one million rather then an exact number. Besides, as was pointed out in Austin Powers, “One Million Dollars” just sounds cool.
Do you believe the first million is the hardest? Why or Why not? Do you believe achieving a million dollars, or thereabouts, changes your situation.