In 1995 Grandpa wrote “Fund Your IRA Every Year, or How to Retire Wealthy by Driving Used Cars.” Twenty-five years later the message remains true and I think bears repeating: time and 1 compound interest work wonders. So, I want to break it down for you.
The MSRP (Manufacturers Suggested Retail Price) for a 2019 base model Ford Taurus SE is $29,000. The Kelley Blue Book Fair Purchase Price for a 2009 Ford Taurus SE is $5,000. Right away you can see how buying the 10-year-old car frees up $24,000 for you to invest. Using a compound interest table (2) we can determine that if you invest $24,000 at 7% interest (3) compounded annually, you will have $617,500 in 48 years; right about the time you turn 70. And this is totally ignoring the money you’ve saved by not paying interest on a car loan.
But wait, there’s more! Driving a used car instead of a new car means you can purchase Liability Insurance alone without needing Collision and Comprehensive Insurance coverage. Liability Insurance costs approximately $3,100 per year while adding Collision and Comprehensive Coverage for the same vehicle adds $2,100 to the bill. Using the same compound interest table, we know that $2,100 invested EACH YEAR earning 7% compounded annually becomes $742,000.
But wait, there’s more! Once you come up with this plan and have started saving your $2,100 per year you can go to your Grandparents with what you’re doing and see if they would be willing to match your savings plan by some amount. Let’s imagine that between each of your three sets of Grandparents and myself your savings get matched dollar for dollar; so now you have $4,200 per year, invested at 7% compounded annually for 48 years. That’s worth $1,484,000 in 48 years. Yes; the $4,200 invested each year ALONE becomes $1,484,000 all by
itself; that’s the power of time and compound interest. If you were able to start by investing $24,000 then the total is now worth over $2,000,000. That’s the power of combining time and compound interest; which means the EARLIER YOU START THE BETTER.
And finally; if you save all this money into a Roth IRA then it compounds for you tax free; which means you will get to use ALL this money in retirement (at least until the laws change; but we will deal with that when the time comes). And you can invest up to $6,000 a year into a Roth IRA, so there’s an opportunity for tax-free compounding of even more money than we’ve used in our example.
So, here it is, step by step:
1. Save enough to buy a used car for cash; use $6,000 from the cash you saved but didn’t spend on the car to open a Roth IRA in a common stock mutual fund. Use anything (4,5) left to open a taxable account in a common stock mutual fund.
2. Purchase liability insurance only, add the money you save from NOT purchasing collision/comprehensive insurance to your Roth IRA every year (set it up to come out of your bank account every two weeks so you aren’t tempted to skip…)
3. Share your plan with your grandparents and I, let us know you aren’t relying on Social Security or Pension Plans, talk about how excited you are to be saving; and see if we are 6 willing to help you save. It won’t hurt to mention that helping you save could be part of our estate/legacy planning. (I will tell you more about estate taxes in another letter.)
4. The first $6,000 in savings (regardless of the source of the money) is contributed to your Roth IRA every year; anything you can save over $6,000 goes into a taxable investment account.
Keep working it. Apply the lessons we talked about before in terms of working, saving and investing.
Let me know if I can help. I love you, Dad
Get in touch to discuss your financial aspirations and needs. at Muhlenkamp & Company, making your money grow is our top priority.
3. I’ll explain why I use a 7% interest rate in another letter; just go with it now for demonstration purposes.
Roth IRA, so there’s an opportunity for tax-free compounding of even more money than we’ve
used in our example.
4. See Letters to My Daughters: On Stocks and Bonds; On Passive Investing; and On Inflation Risk.
6. Letters to My Daughters: On Retirement
7. https://library.muhlenkamp.com/wp-content/uploads/sites/3/2015/01/Working_Saving_and_Investing.pdf ;
Letters to My Daughters: On Financial Freedom