$10 A Day Keeps The Retirement Woes Away

Includes: JNJ, KMB, MCD, PEP, PG, T, WBA
by: Eli Inkrot

The wealth-building equation is made up of just a few basic tenets. Now the exact components and relevance of each principal could be debated, but in general most would probably agree that "establishing an emergency fund," "eliminating debt" (or else using it wisely) and "making more than you spend" are fundamental to the formula. Let's talk about that last one for a bit: making more than you spend. It appears relatively straightforward and in reality it really is. Unfortunately for a lot of people it is much too easy to fall into the "spend more than you make" crowd. In fact, around 20% of Americans have a negative net worth. In hindsight, I suppose this figure simply wouldn't be possible without credit cards, student loans, mortgages and other debt instruments. But then again there's a tangible case for using debt in a reasonable and wise fashion. I'm not here to determine your applicable opportunity costs. I am, however, here to demonstrate the power of time and seemingly small amounts of effort.

First and foremost, I would like to advocate that "making more than you spend" is a much more fundamental concept than simply "making more money." After-all if you make $2 million every year for the rest of your life but decide to spend say $2.1 million a year, then you won't get very far; much less retirement. On the other hand if you make $30,000 a year, while spending $25,000 or better yet $20,000 a year, then your chances of reaching a fulfilling retirement are infinitely greater. So for the following example to work we must assume that you are rationally bringing in more than you are handing out. Now I have no idea how much money you make. But whether it's $10 an hour or $100,000 a year, I don't think that saving $10 a day is too unattainable; that's just over $300 a month or $3,650 a year. If you truly get down to it there are likely a variety of unnecessary, or even unwanted, expenses that you currently have. Even if you don't have these superfluous outflows, that doesn't prevent you from making additional funds. So let's see what the value of saving and investing $10 a day might be:

Notice that this screenshot is precisely similar to the one provided in the article: "What a difference 10 years makes" where I discussed the immense incremental benefit that investing for an additional 10 years can provide. The above calculations were not focused on the assumption of time, but rather consistent effort. By hiding some rows and columns you can already see the punch-line from the screenshot, but we'll get to that soon enough. It should be noted that moving forward the model waits until the end of the year to invest and reinvest dividends that would be received throughout the year. And while this likely understates the end result, there are other factors that would work to counteract this. For example, one might have to account for taxes and the idea that our assumptions, a 3.3% dividend yield and a 6% yearly dividend growth rate, might not be met.

Let's spend a brief amount of time on the assumptions, as I would like to suggest a variety of comforts. First, if you invest in a wide collection of strong dividend-growth companies like: Johnson & Johnson (NYSE:JNJ), Procter & Gamble (NYSE:PG), McDonald's (NYSE:MCD), AT&T (NYSE:T), Kimberly-Clark (NYSE:KMB) and PepsiCo (NYSE:PEP); then you probably won't have much trouble with the minimum yield and growth requirements.

Furthermore, even if you suspect that dividends will not be able to grow as quickly in the future, then you still stand a great chance of averaging 6% growth over your time period. For example, let's imagine that you happened to buy Walgreen (WAG) at a 3.7% yield and expect the dividend to grow at 12% a year for the next 6 years. In order for WAG to compete with a 3.3% yield growing at 6% a year for say 20 years, then WAG would only have to grow its payouts by roughly 2.7% a year in the years 7 through 20. Even if you expand your time frame to 40 years, WAG would only need a yearly growth rate of about 4.6% in years 7 through 40. Additionally, the larger payouts in the beginning would have a greater benefit once the time value of money is considered. Taxes, volatility and frictional expenses are excluded from analysis, but partially included via understating our assumptions. That is, while there are limitations to the above model it works just fine for illustrative purposes.

So let's move on. If you collected $10 a day, aggregated the savings, then invested and reinvested in a collection of dividend growth companies with an average 3.3% yield and 6% yearly dividend growth rate, how much income would you be generating in the future?

The answer is about $60,700 in 40 years time or about $19,100 in today's purchasing power, if you assume constant inflation and contribution increases of 3%. Furthermore, in 14 years one would achieve a nominal income stream of about $3,700 or more than one initially started to invest with for the first year. In year 18, one sees the nominal income jump to just over $6,200 or roughly $3,760 in today's purchasing power. In fact, we see this same trend with any amount of contribution: in 14 years of indexed contributions one would receive the original nominal investment back in dividends and in 18 years of indexed contributions, one would receive the initial investment back in today's purchasing power terms. But look at what's happening in the overall picture. If you save $10 a day, aggregate and invest this amount yearly and consistently find a dividend growth portfolio that yields 3.3% and grows at 6%, then you would have over $19,000 worth of today's purchasing power in yearly income, 40 years from now. Now I know that these seem like a lot of assumptions. But as described earlier, it doesn't appear to be overly unachievable. To be fair, just like I don't know how much you make, I don't know how much money you are going to need in the future. However, I would suggest that $19,000 worth of purchasing power would certainly take care of many fundamental needs.

Of course we aren't just limited to saving $10 a day. Let's say that you are able to invest $20 a day, or $7300 a year. This equates to a year-40 dividend stream of $121,400 or about $38,300 in today's purchasing power. Have enough to put away $40 a day, or $14,600 a year? Now we're really cooking with $242,900 in yearly income in year 40, or about $76,700 in today's purchasing power.

Of course the obvious disputes to these simplifications are easy to recognize: time and effort. Most investors don't have a 40-year accumulation phase ahead of them. I acknowledge that these criticisms exist, but I don't necessarily recognize them as excuses. In making our assumptions it's clear where the outputs come from. If you have less time, you must put in more effort (money). If you have less effort, you must put in more time or else more future effort. I realize that this is neither easy to accomplish or overly opportunistic. But there is comfort within the math. Instead of saving and investing $10 a day, perhaps we keep the same $19,000 purchasing power goal but pump up or contributions to $20 a day. Instead of 40 years, it only takes the $20 a day 30 years to reach $19,000 worth of purchasing power. Bump it up to $40 a day and you're there in 21 years.

Here's the takeaway: in anything you do, success is likely at least partially derived from time and effort. Now is not the time to be concerned about not making a particular goal or to feel overwhelmed. That's what yesterday was for. Today is here for you to make the best possible use of your time and effort. Let's say that you make $100 a day and spend $90 a day on average. If you have an adequate emergency fund, a sizable retirement account and don't foresee any upcoming expenditures that you can't handle, perhaps you're perfectly happy with your situation. But if you happen to "wish" or "feel" that you could be doing more, you have three options: spend less, make more or better yet do both. Even if you can bump your income up to $105 a day and your expenses down to $85 a day on average, we have seen the value in saving an extra $10 a day over time. The point is that by simply saving a few extra bucks a day you can avoid a lot of future troubles, not to mention retirement planners that may or may not have your best interest in mind. I wish you time and effort; and if not both then at the very least the wherewithal to appreciate their inherent connection.

Disclosure: I am long JNJ, PG, MCD, T, PEP, WAG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.