It’s been said that every dollar that you save (and invest) during your twenties will provide one dollar of investment income during your sixties. But is this really true? I recently ran across an interesting test of this idea, and the results were enlightening.
Assuming that an individual invested $1000 once in a single year and did not contribute anything further, he used Shiller’s data to calculate the total return of this investment (including dividends) over the years. He then looked to see how long it would take for the dividend income to exceed $1000 in a single year.
On average, he founds that it took 35 years for a $1000 investment in the S&P 500 to produce $1000 in dividend income in a single year. In other words, you might reasonably expect money that you invest at age 25 to produce an equal amount of income when you turn 60.
The shortest time required to get to the magical $1000 dividend mark was 27 years, for those who started investing in 1941. The longest it took was 45 years, for those who started investing in 1928.
Interestingly, the time required to reach the $1000 mark has been steadily increasing since it bottomed out in 1941, so it’s important not to read too much into a single data point like the average time required.
It’s also important to note that he ignored transaction costs, taxes, and inflation. While transaction costs are quite low nowadays (on the order of 0.2% annually), these costs would still slow down the approach to $1000 in dividend income.
As for taxes, these can be reasonably ignored if you’re investing in a tax-advantaged account, but they would otherwise create significant drag on your investment performance due to the dividends being generated (and reinvested) each year.
Finally, since he ignored the effects of inflation, we’re talking about nominal (not real) dollars in this case. Thus, that $1000 in income won’t be worth nearly as much 35 years from now. Then again, as you approach retirement age, you’ll probably shift into more income-oriented asset classes.
Regardless, this is an interesting test of a handy rule of thumb, and it really underscores the value of starting young. If you’re no longer in your twenties, you can still use it to generate rough prediction of how things might look in the future.