Saving a million dollars for retirement does not require amazing stock picking skills or a lavish compensation package. For many people, a comfortable retirement can be obtained through simple investment strategies utilized at the right time.
I'll take a look at three ways to push your retirement savings toward a million dollars or more.
1. Starting early
Time is a valuable thing and using it right could have a big impact on meeting your retirement goals. Due to the effects of compound interest, an individual who starts saving in their 20s or 30s can wind up with far more in their retirement portfolio even if they contribute the same amount of money in total.
Consider a scenario where the investments earn a modest 5% annual return and the individual retires at 65 years old. If this person contributed $100,000 by age 25, they would have over $700,000 by retirement, but if that person made this contribution at age 45, they would only have about $265,000 by retirement.
Starting early also gives a person more time to make more contributions. If the person in the previous example also began contributing $100 per month at age 25, their retirement portfolio would be worth nearly $850,000 by retirement. But starting with the $100,000 at age 45 and only adding $100 a month from there would result in a retirement portfolio worth a little over $300,000.
While it can be tough for people early in their careers to have extra money to save, it's worth keeping in mind that a dollar saved and invested at age 25 is worth more than twice as much as a dollar saved at age 45 based on a 5% return.
2. Tax-advantaged plans
While taxes can take a big bite out of your returns, there are ways to reduce the amount you owe to Uncle Sam. In fact, the government encourages us to use tax-advantaged retirement plans to build our retirement portfolios.
Traditional IRAs and 401(k) plans let you deduct the contributions from your income taxes upfront, and also allow the money to grow on a tax-deferred basis. But the money is not tax-free forever. Distributions from the plan, which become mandatory after age 70.5, are taxed at ordinary income rates.
But even with this taken into account, IRAs and 401(k) plans can be important tools to let your money compound away tax-deferred as you save for your retirement goal.
And there's another advantage the often accompanies 401(k) plans. As defined benefit plans have become less common among businesses, many employers have replaced them with defined contribution plans. In many cases, these plans come with a 401(k) match where the employer will contribute extra money to an employee's 401(k) plan in proportion to the employee's contribution.
In saving for retirement, taking advantage of these matches is often the best investment you can make because it provides an immediate bonus to your savings and does not entail the investment risk normally required to grow money. Even just by getting another $100 per month in employer match during a 20-year career can mean nearly another $40,000 in retirement when earning a 5% annual return.
3. Avoiding fees
Fees from various funds can easily eat into your returns without you realizing it. While a 2% per year fee may not sound like much, it can mean significantly less in your retirement portfolio when paid over the long term.
Consider that if you put away $100,000 for 20 years and earned a 5% return, you would have over $265,000 by the end. But with just a 2% annual fee, your $265,000 drops to just over $177,000.
Investing with no fees is difficult, but using index funds over actively managed ones can reduce fees dramatically. Fees for a broad-based S&P 500 index fund are only around 0.1% annually, and even many index funds holding international stocks can be had for well less than a 1% annual fee.
Extra fees are one of the big reasons why Warren Buffett, despite knowing all sorts of money managers, has asked that his heirs put his money 90% in low-fee S&P 500 index funds and 10% in short-term government bonds.
Overall, fees can be a major drain on your retirement savings, so make sure you aren't overpaying as even fees that appear small can cost you big in the long-run.
Saving for retirement
Saving for retirement is a decades-long process, but starting early, using tax-advantaged accounts, and avoiding excessive fees can play a big role in helping you meet your retirement goal.
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