Do you have the dream of becoming a millionaire? A $1 million nest egg could potentially buy you financial freedom and let you live in retirement without being restricted by an extremely fixed income.
Saving for this goal can seem intimidating but if you can start early and adopt a disciplined investing strategy it can be done. Here's how.
How your money could grow
Buying shares of the SPDR S&P 500 ETF Trust (NYSEMKT:SPY) lets you participate in the returns of the S&P 500. And over the last 33 years, this index has earned an average rate of return of 9.757%. The SPDR S&P 500 ETF currently trades at $413 per share, and if you invested this amount every month over this same time period earning this rate, you would've grown your accounts to $1.09 million. Past performance doesn't guarantee future performance and the cost of this exchange-traded fund (ETF) will fluctuate as time passes, but if you buy one share of it at its current price over the next 30 years, your accounts could grow by just as much.
Dollar-cost averaging and its benefits
When you dollar-cost average, you put equal increments of money into your investments over time -- in this case $413 every month. This strategy has many benefits but one of the biggest is that it gets you investing consistently over time. Timing the market and trying to buy in when prices are low can be tempting, but getting this right is hard. And rather than guessing these times right every month, what you might find is that your money is sitting in cash longer than you want and missing out on stock market growth. These days of missed appreciation can add up over time and drag down your overall investment rate of return.
This method can also help you create good savings and investing habits because it requires that you budget for it. Once it becomes routine, you can even work on increasing the amount of money you contribute as you earn more money, which could help you accumulate more wealth.
You also benefit from the power of compound interest when you use this strategy. When this happens, not only are your contributions earning interest, but the interest that you earn eventually starts earning interest as well. And the more often you're making contributions into your accounts, the more pronounced this effect becomes.
Time in the market
If you invested in a portfolio of 100% stocks from 1926 through 2020, you'd have earned an average rate of return of 10.2%, but depending on the decade that you invested, that rate of return could vary greatly. If you'd invested in SPY between 2001 and 2010, you would've only earned about 3.5% per year on average. But if you'd invested between 2011 and 2020 that annual number would've increased dramatically to 13.8%.
If you started off investing in 2001, you might've been discouraged by seeing low growth over 10 years. This could've even resulted in you selling out of your investments. But this move would've cost you big and you would've lost out on the next 10 years of growth. It would be great if you could completely skip the decade that performed poorly while reaping all of the benefits of the decade that performed well, but unless you have a crystal ball, this will be impossible. The stock market moves in cycles and within those cycles are bear markets, bull markets, and flat markets. That's why time in the market and being consistently invested are more important for your long-term growth than timing the market.
If you had 20 years before you planned on using your money and experienced a year like 2008 when large-cap stocks lost 37%, you would've had plenty of time to recover from these losses. If, however, you experienced this type of loss when you were a year or two from retirement, you may have ended up delaying this milestone.
You can reduce this type of risk by adding some safer securities like bonds into your portfolio. But reducing your volatility means that you'll probably get a lower average rate of return, which could change projections of how your money could grow. Accounting for these changes and making necessary adjustments like increasing your monthly contributions or decreasing the amount of money you plan on saving can help ensure that you're still meeting your objectives as your appetite for risk decreases.
You can save $1 million. The earlier you can start, the more your wealth can grow from stock market appreciation. And adopting a strategy that helps you develop consistency and takes the emotions out of investing can help you better reach this goal.