The first $100K is the hardest when investing in shares. Not only are you learning how to invest and what to invest in, you are also likely figuring out how to reduce your spending, keep a budget and manage your finances.
Perhaps you have only recently found out where you are in the stages of financial independence.
And then there’s the psychological side of going against consumerist norms by not spend, spend, spending on mindless wants.
Financial literacy is not a side effect of wealth. Wealth is a side effect of financial literacy.Unknown
On top of behavioural changes, compounding interest on your investments doesn’t really ramp up until you have larger amounts of money and time to see big gains.
Whilst the first $100,000 may be the hardest, it is also the most satisfying due to the exponential growth in your own learning and ability to manage money. Reaching $100K is a proud moment and a reason to celebrate.
The purpose of this article is to show how compounding interest increases over time until a figure of $1 million is reached via a case study that illustrates what everyday Aussies can achieve financially.
I’ve chosen $1M as the target number for the case study as $1M when calculated by the safe withdrawal rate of 4% produces a passive income of $40K every year. That’s money you can live from without having to work.
Let’s get into the details of this compound interest case study.
The average Australian wage is $86,268. However, this figure does not reflect the everyday Australian as it takes into account all wage earners – including the poor and the exceedingly wealthy. These figures are added up together and then divided by the amount of people to come up with an average. It’s not a true reflection of everyday Aussies as it is skewed by the top earners and their very large incomes.
What we really need for this case study is the median wage. That’s the wage that the majority of Australians earned.
During 2019 the median wage for Australians was $57,200. This is the figure used in the investing calculations as it represents the lived experience of the majority of Australians.
The case study example includes a couple who are both working full-time. They live completely from the wages of one person and fully invest the wages of the other into index funds in the share market.
The global share market has an average return between 7 – 10%. I’ve used a plausible return of 8% for my calculations. However, this amount may be too low as the average return on the Australian share market since 1900 is 13.21%. Although, I do recognise that the past does not define the future.
I’ve also included 3% pay rises in the calculations so that wages keep up with inflation.
Usually I use the Australian government MoneySmart website for their compound interest calculator but sadly it does not allow for calculating monthly increments, only annual. The compound interest calculator used for the example in the article is from the website ‘Financial Mentor‘.
Of course, each couple has compulsory superannuation which they will be able to access after 60 years of age. This money from super is on top of the money invested in the share market and could be considered ‘bonus’ money.
Taxation and Medicare
Before we get compounding, first we need to run the median Australian wage through an income tax calculator, in this case I’ve used the government MoneySmart website.
- $57,200 p/a = $1,100 p/w
- less income tax of $195 p/w
- less medicare levy $22 p/w
- result: take home pay of $880 p/w
For any non-Aussies reading, the medicare levy is what we pay through our taxation for free healthcare. The levy costs 2% of our taxable income.
Taxation is charged at 32.5%.
In this calculation:
- no tax is paid from $0 to $18,200
- 19 cents in the dollar is paid from $18,201 – $37,000
- 32.5 cents in the dollar paid from $37,001 – $90,000
Let’s Get Compounding
After mastering budgeting, saving, gaining investment know how and at the same time rejecting a consumerist mindset – it’s time to experience compounding interest.
Using a net income of $880 p/w and by investing in the share market with an average return of 8% – it takes 25 months to reach $100,000, or two years and one month.
To be precise, the amount is $102,715. In the short period of 25 months, the investment will have returned $8,555 in interest alone. And we’ve only just got started!
The table below shows how long it takes to reach each $100K until $1M is accumulated. Note: the weekly savings are based on $880 p/w with 3% increases to keep up with inflation. These figures have been put through the income tax calculator in the same method as discussed earlier.
|Initial deposit||Weekly savings||Time in Market||Compound interest||Total Value|
The first $100K took 2 years and 1 month, whilst the last $100K only took 9 months.
The total compound interest returns were $404,574. That’s over $400K in free money.
It only took 12 years to reach financial independence – the point when going to work is optional. Compare this to the average working life of 45+ years.
One million dollars was accumulated on the income of an everyday Australian wage earner. If you earn more, you have the ability to invest more and reach financial independence faster. (Note: the example used is a couple, both in full time work, they live from the wage of one person and invest the wage of the other.)
There are no magic tricks with this – it is just simple maths.
Have a go at putting your wages (or part of) through the compound interest calculator and see if you can figure out how long it will take you to accumulate one million dollars. Please scroll down to leave a comment.
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Disclaimer: This article is in no way financial advice. I am not a financial advisor. Do your own research and contact a professional as needed. Tread your own path.