There are a few big milestones when saving for retirement. Getting the value of your nest egg to $100,000 is one of them. But even after you get that far, the next big step can remain daunting: figuring out how to get your portfolio up to $1 million. It won't be easy, but with the proper strategy, you can put your hard-earned money to work effectively and improve your odds of enjoying a comfortable retirement.
Here are four easy-to-apply rules that can help you grow that $100,000 nest egg into $1 million -- or more -- for retirement.
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1. Start early to get the full advantage of compounding interest
All other things being equal, it is better to start investing early. The sooner you get the magic of compound growth working in your favor, the better. If you're 30 with $100,000 in your portfolio, and your aim is to hit $1 million in retirement savings by the time you are 60, you'll only need to achieve a compound annual growth rate (CAGR) of 8% to hit that goal (and wouldn't even necessarily need to put more away each year). If you reach that point at age 40, though, you'd need a CAGR of 12.2%, and at 50, you'd need to achieve a CAGR of 26%. Of course, most people add to their retirement portfolios each year throughout their working years, but we'll get to that in a following section.
The stock market's long-term average CAGR has been just under 10%, and you shouldn't expect it to trend higher than that over the next few decades. In fact, you should probably expect average returns to be lower for some time, given that the market is near its peak price-to-earnings ratio. So unless you start investing early, you'll have a tough hill to climb to reach $1 million in wealth by the time you retire.
2. Reinvest those dividends
One easy way to accelerate your portfolio growth is to reinvest dividends. Whenever one of the investments in your portfolio pays out a dividend, you can instruct your brokerage to automatically use that cash to purchase more shares of the original asset. As the stock (hopefully) rises over the long term, these reinvested funds will help increase returns.
For example, let's say you invest $100,000 in a stock that grows at an average annualized rate of 6% a year for 20 years and pays a dividend that yields 2%. If you choose to not reinvest dividends, at the end of that period, your initial investment will be worth $320,000 and will have collected $88,000 in dividends, adding up to $408,000. But by simply choosing to reinvest your dividends, that same investment over the same time period would be worth $467,000, or a $65,000 difference. And this is without adding any more capital to your portfolio.
3. Steadily add to the fund each year
Let's say you weren't able to build the value of your retirement portfolio to $100,000 until you hit 40. You may be behind schedule, but it's still possible to grow that into a nest egg of $1 million by the time you turn 60. Just keep adding more money to your portfolio each month and each year.
Let's modify the scenario from section 1. If you invest $100,000 in a stock that grows at an average rate of 6% a year and pays a dividend that yields 2% (which you reinvest), but also buy $10,000 more of that stock each year, in 20 years, you'll have $925,000. That is pretty darn close to $1 million and much more than the $320,000 you'd have without dividend reinvestment or annual contributions.
The more money you put to work over time, the more your portfolio will be worth 10, 20, and 30 years from now.
4. Use index funds if you aren't confident about individual stocks
Lastly, and most importantly, you need to decide what you're going to invest your $100,000 in. If you want to attempt to "beat the market," you'll have to go through the laborious but fascinating process of researching a host of individual stocks.
But if you aren't up for that work, you can easily match the broad market's returns by only owning one asset -- a low-cost index fund like the Schwab S&P 500 Index Fund (SWPPX -0.46%). An index fund is an investment vehicle that tracks a market index like the S&P 500. These typically have very low fees, with total expense ratios of less than 0.10%. Of course, if you can, the best course of action is to buy these index funds in a tax-advantaged account like an Individual Retirement Account (IRA) or a Roth IRA.
If you start early, reinvest dividends, steadily add more money to your portfolio over the years, and use low-cost index funds, you'll have a smooth path to turning $100,000 into $1 million by the time you retire.
