A million dollars seems like a lot of money because, well, it is a lot of money. Thing is, racking up that sum isn't nearly as difficult as most folks imagine. Indeed, after putting just a few sound financial principles into action, you can basically sleepwalk your way to financial independence. Here's a two-step plan (pun intended) for doing just that.
1. Take maximum advantage of your company-sponsored retirement plan.
The 401(k) contribution limit for tax year 2008 weighs in at a hefty $15,500. Even if you can't kick in quite that much, do everything you can to contribute enough to take full advantage of your employer's matching contribution, if one is provided. Hey, that's free money -- and because your contributions will be automatic, once you set the wheels in motion, they'll just keep turning without additional work on your part.
And just how far will those wheels take you? Quite a long way. A 40-year-old who kicks in $10,000 each year between now and age 62 will have more than $760,000 if those investments match the S&P 500's historical rate of return: 10.5% annualized.
Not too shabby, eh?
2. Fully fund a Roth IRA and watch the tax man vanish.
Impressive though the above figure is, you still have some work to do if you want to be a millionaire by the time retirement rolls around. Enter the Roth IRA. Set one of these puppies up, kick in the maximum each year ($5,000 for 2008), and voila: At the end of 22 years, you'll have nearly $343,000 at 10.5%. And get this: Uncle Sam won't expect a dime on the withdrawals, either.
That deal is sweet, indeed, particularly because, unlike with your company-sponsored retirement plan, you're in the driver's seat. You might choose to invest in individual stocks, bonds, or -- if you're looking for a no-muss, no-fuss vehicle -- mutual funds.
Indeed, world-class, actively managed funds make great candidates for IRAs because you won't have to pay taxes on the capital gains and dividends they generate. Still, even if you opt for a "no-brainer" lineup of index picks, you can improve your odds of earning a rate better than 10.5% -- and of becoming a sleepwalking millionaire even sooner.
For example, the iShares Russell MidCap Value (IWS) exchange-traded fund -- which counts Southwest Airlines (NYSE: LUV) and Marsh & McLennan Companies (NYSE: MMC) among its holdings -- tracks a benchmark that cranked out an annualized return of 11.7% for the 15 years that ended with July 2008.
Meanwhile, the bogey for iShares' Dow Jones U.S. Health Care (IYH) ETF -- home to Johnson & Johnson (NYSE: JNJ) and Pfizer (NYSE: PFE) -- has delivered 12.8% over that period. Similarly, the NYSE Arca Tech 100 ETF (NXT) is hitched to a benchmark whose top constituents include Apple (Nasdaq: AAPL), IBM (NYSE: IBM), and Lockheed Martin (NYSE: LMT) and which has delivered a cool 15.7% on an annualized basis.
No matter which way you go, the bottom line with Roth IRAs is this: The market is your oyster. Feel free to pick pearls -- and watch 'em grow, tax-free.
The Foolish bottom line
To be sure, while the big picture of financial planning may be clear -- invest early and often and take full advantage of tax-favored vehicles -- the nitty-gritty of portfolio construction can be, well, pretty gritty.
If you'd like some assistance on that front, consider the Fool's Ready-Made Millionaire service, which features a real-money, set-and-forget portfolio of just eight holdings. Among them: a high-octane ETF designed to double up each day on its underlying benchmark.
RMM is opening to new members in October, but by way of a preview, you can peruse The 11-Minute Millionaire, a special free report designed to help you play effective offense and defensive. If you do a good job of protecting your nest egg when times are tough, after all, you'll have more skin left in the game when the market resumes an upward trajectory. Just click here to learn more about RMM and to snag the report -- all for free.
This article was originally published on Feb. 9, 2007. It has been updated.
Shannon Zimmerman runs point on the Fool's Ready-Made Millionaire service and doesn't own any of the securities mentioned. Pfizer and Johnson & Johnson are Motley Fool Income Investor recommendations. Pfizer and Marsh & McLennan are Inside Value choices. Apple is a Stock Advisor selection. You can check out the Fool's strict disclosure policy by clicking right here.
