When you think about retiring a millionaire, it may sound like you could live like the rich and famous -- spending your retirement on a yacht, sipping champagne from gold-plated glasses.
But in reality, $1 million may or may not be enough to last through retirement, even if you live a modest lifestyle. Consider the 4% rule, which states that you can withdraw 4% of your savings during the first year of retirement, then adjust your withdrawals each year afterward for inflation. If you have $1 million saved by retirement age, the 4% rule suggests you can withdraw $40,000 your first year. That's not exactly the life of luxury that comes to mind when you picture becoming a millionaire.
In other words, $1 million isn't necessarily a far-fetched retirement goal -- so it's a good idea to save more than you think you need to. Retiring a millionaire may not be easy, but it's absolutely doable if you follow a few simple money rules.
1. Don't be too conservative with your investments
Playing it safe with your money may sound like the most practical thing you can do to establish a solid retirement fund. However, play it too conservatively and you may end up doing more harm than good.
For anyone who's not already a member of the super-wealthy club, one of the best ways to accumulate enough savings to reach millionaire status is to invest in the stock market. Now, that's not to say you should invest your life savings in that hot new tech start-up; instead, put your money in low-cost index funds and mutual funds. Although the stock market will always experience ups and downs, these types of investments are a relatively safe bet over the long term. Over the course of several decades, you'll typically see average annual returns of around 6% to 10% with these investments.
Compare those returns, then, to the returns you'd see with a savings account or lower-risk investments like CDs and money market accounts. Even the best savings accounts have interest rates of around 2%, and the annual returns for CDs and money market accounts typically hover around 2% to 3%. At that rate, your savings may not even outgrow inflation -- meaning your money could actually lose value the longer you keep it in these types of accounts.
The difference is eye-popping when you look at the big picture, too. Say you're 30 years old with nothing saved for retirement, and you're saving $500 per month. If you're earning an 8% annual return on your investments, you'd have just over $1 million saved by age 65. A 2% annual return, however, will result in total savings of just $300,000, all other factors remaining the same.
2. Start saving as early as possible
Time is your most valuable asset when it comes to saving for retirement, and the earlier you start saving, the easier it is to build a healthy nest egg.
Thanks to compound interest, your savings will snowball over time. So even if you don't have much to save when you're younger, simply getting started and stashing something for the future will pay off big time down the road. And the longer you wait to get started, the harder it will be to catch up.
Say you want to retire at 67 years old with $1 million in savings. If you start saving at age 25, you'd need to save around $375 per month to reach that goal, assuming you're earning a 7% annual return on your investments. If you were to wait until age 35 to start saving, though, you'd need to save around $800 per month to reach that same goal.
Additionally, even if you don't have much to save now, that doesn't mean you won't be able to bump up your savings in the future. It's easy to shove retirement saving to the back burner because you think saving what you have now won't amount to anything. But if you save a little now and then start contributing more once you get that raise, change jobs, etc., you'll still come out ahead compared to if you'd waited to save anything until you started earning more money.
3. Don't touch your savings until retirement
In order for your savings to grow as much as possible, they need to be left alone. It can be tempting to dip into your retirement fund when you need extra money to fix the car or round out the down payment on a house -- after all, how much harm can a few thousand dollars do when you still have decades left to save?
In truth, even relatively small withdrawals can set you back significantly over time. To get a better picture of just how much they can potentially hurt your long-term savings, let's look at a hypothetical example.
Say you're 30 years old with $25,000 in your 401(k). You're saving $375 per month, and at that rate, assuming you're earning a 7% annual return, you'd have around $1,027,000 saved by age 67. In a different scenario, say you withdrew $5,000 from your retirement fund at age 30, but you continued saving $375 per month until age 67. First, you'd have to pay a 10% penalty on that money because you withdrew it before age 59 1/2. Second, your savings would only amount to around $965,000 by age 67, all other factors remaining the same.
In other words, you'd not only have to pay an up-front fee of $500, but you'd also lose around $62,000 in potential gains from just a $5,000 withdrawal. If you make a habit of withdrawing money from your retirement fund, it could add up to tens or even hundreds of thousands of dollars in missed potential.
Retirement is becoming more and more expensive, and you may need upward of a million dollars to live out your golden years comfortably. Retiring a millionaire may sound like a lofty dream, but if you're strategic about how and when you save, it can become a reality.