Rainy Day Pennies: Commentary on Ramit’s Book “I Will Teach You to be Rich”: What if You are Dumb Dan?

In Ramit Sethi’s new book I Will Teach You To Be Rich, he demonstrates the power of compound interest with the example of Smart Sally and Dumb Dan. (There is an error as of this writing as mentioned in Calculation Error in Book I Will teach You to be Rich, but the point and the correct calculation is still relevant). What if you are Dumb Dan? You are in your 30s, and you haven’t saved $100 monthly for the past 10 years.

The first thing to realize is if Smart Sally is out there right now doing this, barring any stupidity like getting entangled with a financially irresponsible boyfriend/spouse, she will always be younger, smarter and and probably richer than you. She has the advantage of time. You, Dan, can’t change the past, but you can change the now and the future. And you can lecture the whippersnappers like Sue not to be like you.

So congratulations, you’ve realized the error of your ways. You are going to be Smarter Dan. Download this Smarter Dan Spreadsheet. “Smartest Sally” never stops contributing every month, and increases her contributions by 5% every year until retirement. She has approximately $624,158,39 with 8% interest compounded over 40 years. (The 8% interest is a toy problem – we will discuss real world returns from index funds later.) What a nerd. <insert dripping envy here>

Dumb Dan – you blew it. You’re in the 30 something club with no real savings to speak of. The good news is you can still benefit from compound interest. You just have to put more money up front in a shorter period of time. If you start off by contributing $600 every month, then decrease your contributions every year, you can still end up near Sally’s balance at retirement. (“Decrease?! What?!” See note below.) You will have to delay buying your first home, drive a beater car, and take modest vacations. If you have a hardship year, you’ll have to sacrifice more. Yeah, $600 per month for the first year. $7200. That’s a lot of freaking money.

Sally will still be ahead of you. She will have earned more money that she didn’t have to put into her retirement funds and could invest the excess elsewhere, bought her first home with 20% down at 28, paid for her new $18,000 car in cash, and vacations in the Bahamas. If she had a hardship year, she had more money to fall back on.

I agree with Ramit’s point. If you’re a 20 something, be Smart Sally. If you’re Dumb Dan, be Smarter Dan. You’re just going to have to put in about 6 times as much upfront. It may not be possible depending on your income potential and obligations, and you’ll just have to adjust to realistic levels for you. If you missed out on your youthful compound interest years, it doesn’t mean that you can’t have a wonderful and meaningful retirement. Don’t compare your success with Sally’s. Be proud of your own accomplishments, the wisdom to recognize your past failings, and the smart decisions you’ve made moving forward.

Note: The point of this toy spreadsheet exercise is to show that even if you are starting late, it is possible for you to ‘catch up’. You just have to put a lot more upfront into it. The point remains the same – Sally benefits from compound interest with less upfront and lets time do its magic.