OK, young whippersnapper, you have a choice in life. It's a pretty good one, with both options turning out well for you. Choose the first and retire extremely comfortably. Choose the second, and you will be able to enjoy the golden years of your life with more money than you can spend. Both of these outcomes are a result of your willingness to commit capital early and often to investing in stocks.
Which will you choose?
Wait, don't answer yet. There's a little bit of a catch. To have the best opportunity to be seriously rich, you're going to have to commit to doing three things. This may seem easy, sort of a Gremlins-style "don't feed the Mogwai after midnight." But it isn't. Perhaps we should discuss how to achieve the first goal, uh, first: How to retire with a comfortable nest egg. This happens to have one step, with a caveat. But whatever.
The one-step (with a caveat) program to retire in comfort
Are you ready? In order to ensure a comfortable retirement, here's what you must do: Fund your IRA. Each year, every year, put money into an individual retirement account. And here's the caveat: You should fund your IRA as soon as possible each year. Don't wait to do it until the April deadline, which the tax code allows. Do it as soon as you possibly can. The difference in the time value of that money for every single one of those dollars having an additional 15 to 16 months to grow is astounding. Over a 20-year period, the simple act of funding as early as possible rather than waiting for the last moment can mean a difference of $12,000 or more. This will only increase as the annual investment limits increase from $4,000 to $5,000 in 2008.
Twelve grand isn't necessarily enough money to retire on, but it spends. If you can't commit it all in a lump sum, break it down into month-by-month contributions: $4,000 per year is $333 per month. Don't think you can do it? Some people truly cannot. Most could, if they were to rein in their spending a wee bit. My colleague Rex Moore offers a clever discussion of this in a recent article.
So easy, and so few do it
You know the old saws. "Pay yourself first," "if you can't pay cash, you probably can't afford it," and "stay away from my rhinoceros." (OK, I may have made the last one up.) In a nation of families absolutely drowning in credit card debt as a result of our "I want, therefore I buy" mentality, these old saws are not exactly getting worn out from overuse. A few years ago, the AARP put together a study on people between 50 and 61 years of age that found that the median retirement savings amount for the lowest quartile of wage earners is $6,000. That's not going to get it done, and it must be terrifying. These people have managed, on average, to save a maximum of $5.76 per week for their entire working lives. And that's assuming 0% growth in those saved assets.
If you fund your IRA every year from a young age, you almost cannot help but have a healthy retirement kitty. Put that money into an S&P 500 index fund, perhaps some high-quality blue chips like Coca-Cola
None of us knows what the future holds, but that plan almost cannot fail. And you know what? When you have that nest egg all along the way, you have options. Once you've paid yourself first and built up your account, a splurge or two won't be the difference between filet mignon and dog food when you retire.
About the seriously rich thing ...
"Great!" you say, but what was that about being "seriously rich"? Yeah, I was serious about that, and it doesn't require that you go out and marry someone named Rockefeller. The first step to wealth, interestingly enough, is the one we've just talked about. To have money to invest, you must first accumulate that money. Save, save, save. Once you've funded an IRA, you can also put money into your brokerage account. The difference in the approaches is one of activism versus passivity. If you want to retire well off, you can buy the averages and you'll do great. If you wish to exceed that by a wide amount, you're going to have to work at it.
So, step 1 is to save. Step 2 is to learn. Read the greats. Read Joel Greenblatt's recent book, The Little Book That Beats the Market. Read Buffett, read Graham, read Ben Franklin, read Bill Miller. Understanding how the best people in the world managed their money, their affairs, and their investing philosophies gives you a road map to do the same. But if you read enough, there's one thing you're bound to notice. Few if any of the world's most successful investors needed to invest in bleeding-edge technologies or speculative micro caps to become wealthy.
Philip Fisher did it by buying financially strong companies such as Dow Chemical
The hardest step
Getting from well-off to seriously rich requires one other thing. I call this a step, because it can be learned, but for some it's just innate. To become really wealthy, you must be able to determine when the market is overestimating a risk and when it is underestimating it. This is to say that you must be able to learn to stop caring what Wall Street thinks, what the business section thinks, what your fellow investors think. You must be able to stomach days when your stocks drop 20%, because you know you're right. You must be able to look at a savage headline and say, "That's really interesting, but it misses the point."
To be seriously rich, you cannot worry that your neighbors are suddenly plowing their money into some moonshot company. You must learn to live with people telling you that what you're doing is "extremely risky" when you know that the risk is overstated. And most importantly, you have to learn to be wrong on occasion, and recognize that as the cost of floating upstream.
Of course, some things seems risky because they are. Those folks who are warning you that running with a lit match through a nitroglycerin plant is insane just may have it right. Just as Buffett recognized that the Salad Oil Scandal wasn't going to destroy American Express, many investors recognized in April and May of 2005 that the likelihood that Elan
Seriously rich? The stock market has done that very thing for millions over its history. But it requires work.
Want a leg up?
One thing that I like about the retirement message is that it is one of the few investing pursuits that starts with an end goal in mind. Sure, you can invest your entire life, but you're really seeking to ensure that the day you stop working isn't one that strikes fear in your heart. Being wealthy gives you options. Being comfortable does the same. My colleague, Robert Brokamp, runs a fantastic service called Rule Your Retirement to help you get on track. Think you're too young to plan for retirement? You're not. Think you're too old to make a difference in your standard of living in your later years? Pshaw!
A 30-day trial to Rule Your Retirement is free. No, seriously. It's free. Just click here.
This article was originally published Feb. 3, 2006. It has been updated.
Bill Mann holds shares in Elan. Coca-Cola is a Motley Fool Inside Value recommendation. XM Satellite Radio is a Rule Breakers recommendation. Dow Chemical is an Income Investor pick. The Fool'sdisclosure policyis awesome.