You may think that becoming a millionaire can happen only if you win the lottery or inherit a ton of cash. And while these are quick and easy ways of gaining entry into the millionaire club, the chances of these events happening might be low.
Rather than leaving it to chance, making these simple changes to your savings and investing habits can get you there as well.
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1. Start young
Starting young is one of the best ways of snagging the title of "The Millionaire Next Door." If you can invest the money that you save, investment returns combined with the power of compound interest can grow your assets exponentially. If you save $5,250 a year starting at age 25 and earn 10.3% each year on average, your account could grow to more than $1 million by the time you are 55.
You can potentially achieve this rate of return by investing in a portfolio of 100% equities. While this type of portfolio may be suitable for you when you are young, reducing your stock exposure steadily as you near retirement may be prudent. Doing this will decrease your volatility, but you will probably earn a lower rate of return. You can compensate for this lower return by adjusting your annual contributions. Using a calculator, you can determine just how much by factoring in how much you've already saved, how many years you have left until you hit your millionaire goal, and your new rate of return.
2. Be consistent
Projections of how much your money could grow to assume that you'll do the same thing consistently. From year to year, the rate of return that your account experiences will vary. Some years you will have a lot of gains, some years you will end the year flat, and some years you will lose money. Rates of return that predict the potential growth of your account are averages of these different numbers, and missing even one of the best years could change your final outcome. For instance, if you'd invested in large-cap stocks over the last 10 years, you would've earned an average rate of return of 14.5% per year. Missing 2013's 32.4% gain would've dragged your average down by more than 3 percentage points to 11.25%.
There may also be a year or two when you can't make a contribution to your accounts. The more years you miss, the more it could affect your savings goal. When and if you do skip a year, it's important that you rerun any savings calculations and make any necessary adjustments to your contributions going forward.
3. Keep expenses in check
You may think that how much you make is the only contributing factor in how much you can save. But equally important and potentially more in your control is how much you're spending each year. Instead of waiting for the next pay raise to start saving more, you can figure out ways of hitting your annual savings goal by cutting your expenses.
Creating a budget can help. You should start by closely tracking your monthly spending, and from there you can separate your bills into things that you want and things that you need. Essentials like your mortgage or rent can't be eliminated. But expenses like your travel or entertainment budget could be lowered, and the savings redirected to your goal of becoming a millionaire.
4. Invest wisely
Investing too conservatively or too aggressively could make reaching your goals harder. A conservative portfolio may not grow your assets enough in the time span that you need, while a portfolio that's too aggressive may make weathering stock market storms difficult.
Any asset-allocation model that you follow should take into account your risk tolerances and how comfortable you feel with volatility. Taking a simple quiz that takes into account your time horizon and how you've reacted in the past to volatility will help you invest in a way that will best match your investment objectives.
5. Review your accounts regularly
While stocks over the long term do typically have an upward trajectory, that movement isn't without bumps in the road. Even if you are diversified and own a variety of asset classes, they will drift over time. Not adjusting them back to their initial allocations could set you up for subpar investment returns. In a year like 2008, large-cap stocks performed poorly and investment-grade bonds did well. A portfolio consisting of 60% stocks and 40% bonds would've shifted to 47.3% stocks and 52.7% bonds. In the following year when the stock market rallied, this new asset-allocation mix would've underperformed the initial one.
Reviewing your accounts at least once a year and making sure no changes are needed can help avoid this pitfall. You can also check your progress toward your goals during your review. If you are off, these check-ins are a great time and way of getting back on track.
Becoming the millionaire next door doesn't require a fortune. But you will need time, consistency, and diligence. Making these small changes can help you make a habit out of saving and reduce the stress of saving for this lofty goal over time.
