A million dollars just doesn’t buy what it used to. Sure, it’s still a great wealth status to obtain in today’s economy, and for many it’s the first major milestone on the path to generating wealth, but there’s a large difference between what it took to become a millionaire in the past versus today.
In today’s economy, inflation is on the rise and the value of the dollar has been eroding with the passing of each year. We need to take that into account when setting our financial goals because what that dollar buys us today won’t be the same a decade from now. In other words, we need to set goals in real terms, not nominal terms.
Back In My Day …
I always enjoy talking to older generations about personal finances and wealth generation strategies. There’s always a unique story to be told from the context of one’s life, but as I continued to have these conversations something wasn’t adding up.
One common thread in these conversations would be for older generations to exclaim about how little money they made at their first job, and how fortunate I was to be making so much more money today. These conversations became a bit frustrating as older generations insinuated that I somehow had it easier because I nominally made more money than them. As an example, if my grandfather used to make $2.50/hour at his first job, and my starting wage was $9.25/hour, he’d surely believe that I had it easier, right?
Wrong.
What we need to take into account is the relative purchasing power of those incomes for the times that the money was earned. The dollar hasn’t always been a consistent reference point for its purchasing power over time and, in many ways, the dollar has failed to be a stable store of value. Take into consideration this chart showing the dollar’s purchasing power over time.
Credit: Visual Capitalist
Simply put, the dollar has lost a lot of value over time. After all, a soda used to cost a nickel, right? Not anymore.
This fact is significant for anyone with a longer-term financial goal because if your unit of account for setting financial goals is flawed, such as the dollar over a period of decades, it doesn’t serve much benefit to set goals in that denomination. Real estate is a great example of why setting dollar-based goals is a fallacy.
What Do Homes Even Cost?
Let’s take a look at what homes used to be worth in the past and what they’re worth now, and extrapolate that to creating financial goals in the present. Here’s a chart of the median price of a single-family home in the United States over a few decades. I’ve chosen 1971 as the starting point because it was in that year when the United States effectively cut itself off from the gold standard, and went to a fiat-based monetary system.
In 1971, a single family home could be purchased for $23,300, whereas in 2022, it would cost $440,300. This may be somewhat of an oversimplification, of course, because there would be major differences in building materials, lot sizes, home sizes, and other factors, but as a generalization the numbers speak for themselves–on average a family has to spend 19x more dollars today to buy a home to live in.
But How About Household Incomes?
These home price charts don't signify much without comparing incomes for those time periods to home prices, or in other words, the amount of time and effort it would take to be able to afford a single-family home. Here are two charts showing how median household income has changed over the years.
As we can see, incomes increased from $10,285/year in 1971 to $84,008/year in 2020. This is only a 8x increase. While these numbers show a nominal increase in incomes, some basic math will help us put this into perspective to show that the nominal increase in household income didn’t make families any better off when compared to the past.
| Income | House Price | Years to Afford | |
| 1971 | $10,285 | $23,300 | 2.26 Years |
| 2020 | $84,008 | $337,500 | 4.02 Years |
What does this mean? Someone buying a single-family home in 2020 would have needed to work 4.02 years to afford the home, compared to 1971 when it would have taken only 2.26 years of effort.
Shown in a different way, in 1971 one million dollars would have bought you 43 single-family homes, whereas in 2020 it would have only bought you 2. That’s a huge difference, and if your financial goal was based in dollars, you could have stopped in 1971 at 2 rentals and called it a day.
Goals in Today’s Terms
I always suggest to people that they need to set financial goals in terms other than dollars. That sounds like an oxymoron, to gauge finances without a financial denominator, but when the dollar decreases in purchasing power over time it fails to serve as a good gauge for building wealth over a lifetime.
Let’s put this into practice and take the time to reverse engineer what we’ll need in the future, so we can work towards those goals today. First, identify the lifestyle you want in today’s dollar terms, find out what that means in today’s real value, and then determine the goal that would be required to obtain it. For example, I would like to have approximately $240,000/year in passive income in today’s terms. Great! Now we need a denominator. If we simplified that to the equivalent value of real estate, it could be shown as follows:
Average Rent on SFR: $1,200/month or $14,400/year
SFRs Needed: $240,000 ➗ $14,400/rental = 16.67 rentals
To meet my goal of earning $240,000 in gross income per year, I would need roughly 17 rentals. Now I have an actionable goal that will remain more or less consistent throughout time.
As always, be a critical investor.
Let's kick the 9-5.
