Are you way behind in saving for retirement, or haven’t started at all? Good news: There’s a way out of your predicament! Follow these three basic principles religiously and, along with a little luck, you still should be able to achieve your long-term financial goals.
What if you’re about 45 today and have nothing saved…Fear not, you aren’t a complete lost cause. I can give you three basic principles that you could begin following today which very well may, by the time you reach retirement, push you over the million-dollar asset mark.
#1-You Have To Embrace Time
If you think you are going to get to $1M overnight, you’re sadly mistaken. Think of it this way: If you are in your mid-40s with almost nothing put away for retirement, you didn’t get this way overnight. You made conscious or unconscious decisions for years (decades?) to consume and not save. Or maybe you did save and invest and it turned out terribly. Maybe an unfortunate divorce took a big bite out of your savings. Whatever the cause, it’s taken time to get here and it will take time to get out. Don’t look back, start looking forward.
Right now, we consider “full retirement age” to be 65 in this country, and while that may be pushed back a few years in the near future, it’s a rough number we can work with. It represents two full decades where you can get serious and get to work on accumulating some meaningful wealth that should support you for the rest of your life.
Knowing you have time is crucial to our second principle, because it eases your mind during the inevitable short-term periods when things are not going as planned.
#2-You Have To Be Disciplined
I’m not going to lie: It’s going to take a ton of discipline to get you over the $1M threshold. What do I mean by discipline?
1. First, you’re…[going to] have to stop spending all your income. I figure you need to start putting aside $1,500 per month into an investment account, or $18,000 per year and, every year, you’ll need to give your retirement savings rate a raise: Start with inflation, or about 3% per year.
That might sound like a lot, but if you’re lucky, you have a 401(k) plan that includes an employer match, so not all of this savings needs to be yours or maybe you’re fortunate enough to work for a company with a lucrative profit sharing plan…[Some company] profit-sharing contributions add up to as much as 20% to 25% of an employee’s gross salary in some years. If you don’t have a great retirement plan where you work, maybe you should ask yourself how much you really value your employment there and if it’s at all worthwhile moving to a better company which cares more about their employees.
2. Second, you have to own stocks, only stocks. They are the only broadly available asset that has historically appreciated at the rate necessary to transform your monthly savings into serious long-term wealth, which is about 10% annually (the return on the S&P 500 from 1926-2015). There are downsides to this handsome historical appreciation, however: This return has included several serious bear markets where share prices fell by 40% (1973-1974 and 2000-2002), 50% (2008) and as much as 80% (1929-1932). You have to have the discipline to keep investing, month in and month out, even if stocks are dropping in value.
How can you do this? Remember one simple thing: Temporary drops in stock prices (all declines have historically been temporary) provide you with a better buying opportunity. Lower share prices mean you can buy more shares at temporarily depressed prices, and most likely your future returns on these purchases will be even higher than long-term averages. Said differently, in savings mode, you aren’t hoping for consistently high returns on stocks. You’re rooting for bear markets from time to time and only that stocks eventually produce the long-term returns for you that they have historically.
Time and discipline, by the way, are about 80% of what you need in order to be successful. I say this because the latter principle is a major hurdle for most people. As investors, we find it next to impossible to defer instant gratification for savings that we may one day benefit from, at some future point we can barely dream of and, when we’re losing money on our savings that we don’t get to spend today, that’s just rock salt in a major wound. It’s often enough to cause people to throw in the towel completely.
There is another 20% or so, and I’ll conclude with that next but start with time and discipline and master those first. Principle #3 is meaningless without #1 and #2.
#3-Intelligent Investing and Good Fortune
What are you going to do with that big chunk of monthly income you don’t get to spend anymore? Here’s what you aren’t going to do:
- Don’t buy individual stocks.
- Don’t hunt down a mutual fund manager with a great track record.
- Don’t subscribe to investment newsletters.
- Don’t listen to a single piece of “advice” you hear on CNBC.
If you want to keep it simple, put about $1,000 per month into an S&P 500 index fund…and the other $500 into an international stock index fund…every month. At the end of the year, figure out how much you have in each and rebalance them back to about 70% S&P 500 and 30% international. That’s it.
If it were me, I’d go one step further. For U.S. stocks, I would include asset class mutual funds that own large and small value stocks…In international markets, I wouldn’t use the index at all; I’d buy asset class mutual funds that own international large and small value stocks…For what it’s worth, this is exactly what I do in my own personal retirement portfolio…
When we look at these two approaches over the last 20 years (see here), we find that the first earned about 7% annually and got you pretty darn close to your goal – ending with $846,239. The second returned about 2% per year more, thanks to the added benefits of smaller and more value-oriented stocks, and resulted in $1,026,965. Jackpot.
Now, for these results to repeat, you’ll need a bit of good fortune in the returns department. We don’t know for sure what future returns on stocks will be. You’ll need about a 9% return for your $1M goal to be attainable. As the last 20 years show, not all stocks are a sure bet to produce this result, even if it is in line with long-term averages. That’s why I advocate owning smaller and more value-oriented stocks along with a broad-market index fund. These companies have a rich history of achieving higher-than-market returns, tend to offer diversification benefits during periods where broad indexes are floundering (like the 2000-2009 “Lost Decade”), and their slightly higher volatility further aids when you are dollar-cost-averaging.
That’s it. There’s no more magic or silver bullets. No compelling stock picks or market-timing schemes. You don’t need them even if they did work, which they don’t…so get to work. I’ve laid out three broad principles anyone can begin to follow. It won’t be easy, but it’s doable. Stop procrastinating and start saving and investing the right way.
By Eric Nelson (servowealth.com) – The original article was edited ([ ]) and abridged (…) to ensure you a fast & easy read.
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