There's a clear path to becoming a millionaire retiree, but it's a hard one to follow. Most investors can benefit from building a game plan to achieve financial freedom by strategically saving and investing. If you want a comfortable retirement that doesn't depend on Social Security, consider this blueprint for wealth creation.
Save early and often
Saving is the first step in wealth building. It's the most important one, but it's also the most difficult. The average retiree has around $200,000 saved when they stop working. That's not good enough in a world where pensions are disappearing, and Social Security benefits seem likely to be less substantial in the future. We have to be self-sufficient in retirement planning more than ever before.
The personal savings rate in the U.S. has generally fallen between 5% and 10% in recent decades, falling to 6.4% in January. That's a good start, but it really needs to be higher if you want long-term financial success. Most households should aim to save at least 15% of their income each year. That's hard to do, but it's important to set goals and develop a plan.
It might sound like a lame cliche, but discipline is a huge piece of the puzzle when it comes to maximizing your savings rate. Try not to think about saving as a chore. It gets a lot easier if you create measurable goals, monitor where your cash goes each month, and track progress.
Having visibility of your cash flow can remove lots of stress from financial planning. Most people don't know how much of their income winds up being split between taxes, bills, basic needs, and lifestyle expenses. That causes confusion, and it's too easy to think of each dollar spent as a dollar lost. Creating a trackable budget allows you to spend guilt-free as long as you ensure that your goals are being met.
It's also helpful to keep cash separated in different accounts for different purposes. Checking accounts are designed to make spending easy. If you can split a direct deposit into a savings account that's tabbed for retirement goals, that's very helpful.
Investors should also take full advantage of employer 401(k) matches if they're available. Money saved to a 401(k) isn't necessarily better than other types of accounts, but employer contributions are free money that can boost your savings rate. Don't turn your back on free money. Try to max out your contributions that receive a total or partial match from your employer.
If you save 15% of $70,000, that's equal to $10,500 each year, or $857 per month. Someone who squirrels away that amount of cash starting at age 25 would have retained $420,000 by the time they're 65.
Invest for growth
You don't have to settle for $420,000 in that scenario. Any money saved can be invested for growth, whether it's in a 401(k), Roth IRA, or brokerage account.
Early on, investors should prioritize long-term returns. That means a portfolio that's allocated almost entirely to stocks, with a relatively heavy weighting in growth stocks, small caps, and emerging markets -- these are usually considered high-growth, high-reward. If you have 20 or 30 years until retirement, then you can afford to ride out some cycles and volatility. Your 20s, 30s, and 40s should be your highest-growth years.
As you get closer to retirement, you have to find a better balance between volatility and growth. You won't have as much time to recover from market downturns. To reduce risk, older investors allocate more heavily to dividend stocks, value stocks, and bonds. These can still produce growth, but the expected rate of return isn't as high as growth stocks.
The long-term rate of return varies from person to person based on a variety of factors. Most people can achieve somewhere between 7% and 10% on average, based on major indexes. In the example of someone saving $10,500 per year, a 6.8% average annual return would exceed $2 million over a 40 year period. Such great performance requires consistency and commitment, but it's a totally reasonable rate of return to expect.
Building wealth for retirement isn't a smooth road. There will be cash flow interruptions along the way, and the stock market grows in cycles. It's important to keep this in mind as you go. Come up with a sound strategy that's engineered for long-term success, and stick to it.