Who wants to be a millionaire?
One million dollars remains a magic number for many nest egg builders. The word "millionaire" has a delightful zing to it. And assuming a 5 percent annual return on investment, you can reap $50,000 a year in retirement income just by kicking back, which beats the mattress strategy any day. The next million-dollar question is: How do you get there? Consider these 10 sound principles as you invest your way to the seven-figure mark.
Include taxes in your tally.
Withdrawing money from retirement accounts is, of course, not a free ride, so $1 million gross is not $1 million net. "If the $1 million were in a traditional 401(k) or IRA, all withdrawals would be taxable," says Christine Pavel, vice president of wealth management at GCG Financial. "You also have to consider how much the investor will withdraw from the portfolio, and for how long." Assuming 3 percent inflation, looking forward 30 years and accounting for taxes, "an investor would be lucky to be able to withdraw $20,000 or less from the account for 30 years," she says.
Take advantage of compound interest.
If you're in your 20s and start investing now, you're in luck, says Joe Jennings, wealth director for PNC Wealth Management in Baltimore. "Due to the power of compounding, the first dollar saved is the most important, as it has the most growth potential over time," he says. As an example, Jennings compares $10,000 saved at age 25 versus age 60. "The 25-year-old has 40 years of growth potential at the average retirement age of 65, whereas $10,000 saved at age 60 only has five years of growth potential," he says.
Consider annuities as a building block.
Annuities, which provide a payout once they reach maturity, have a rough reputation, particularly indexed annuities. But last year's Qualified Longevity Annuity Contract regulation by the IRS set guidelines for investors to create their own pensions. "You can invest and put money in a retirement account, and with annuity guarantees that you will never outlive your money," says Stan "The Annuity Man" Haithcock, an annuities expert and author of "The Annuity Stanifesto."
Put safety first.
It may seem sexier to get in on the latest initial public offering or that new stock your uncle promises will take off. But that's no way to build a nest egg, says Jim Merklinghaus, founder and president of JBM Financial. "My philosophy has been a conservative approach to retirement, investing consistently over a 30-year period of time. If your principal is 100 percent safe, you have already accounted for 12 years of a normal 30-year retirement. The plan that avoids the loss of principal far exceeds the joy of temporary returns," he says.
Diversify between companies large and small.
Risk tolerance and portfolio mix are major factors in getting to $1 million, and they'll differ depending on the investor. But if there's one universal that applies, "The portfolio should be diversified among large- and small-company stocks, domestically as well as in established foreign countries and emerging markets," says Kenneth Moraif, senior advisor at Money Matters in Plano, Texas. "The appropriate allocation in each of these asset classes will be determined by the investor's time horizon, their current assets, age and tax bracket."
Use that 401(k) all the way.
Since retirement is the major savings goal with most nest eggs, make sure you maximize your retirement savings, says Andy Saeger, vice president and senior financial consultant at Charles Schwab. "Max out your 401(k) or other employer retirement plan, especially if you receive matching contributions. If you're age 50 or older, make catch-up contributions. If you can afford to save more, you may be eligible to open and contribute to an IRA, where your money can grow tax-deferred or tax-free until retirement," Saeger says.
Thou shalt pay thyself first.
What used to be simple, sound advice is more of a commandment when $1 million or more is the goal. "If you make the financial plan first and then build your life around it, the outcomes are typically very positive," says Mike Chadwick, CEO of Chadwick Financial Advisors in Unionville, Connecticut. "Most people do the opposite: They set up their life and then try to save after the fact, when it's painful to do so. When something is paid off, save the extra money and you won't feel the pain. And when you get raises, save the money until you're on target."
Avoid the temptation to spend first.
Most investors, especially in their younger years, think they can easily make up for copious spending and shopping. "This is certainly possible but will require a potentially difficult, if not impossible, return on the investment or a significant increase in savings," says Bellaria Jimenez, managing partner with MetLife Premier Client Group, based in Cranford, New Jersey. "Investors must ignore temptations to spend and instead save."
Just as it takes years to get to retirement age, you'll want to stick it out as some investments hit expected bumps. "Over a typical working career, an investor can expect to experience at least eight to 12 poor market years," says Jakob Loescher, a financial advisor with Savant Capital Management and based in Rockford, Illinois. "During these years, it's important that the individual remain patient and not make any large market-timing mistakes."
And finally, answer the $2.3 million question.
That's how much you'd need in 2045 to have the same purchasing power as $1 million today, assuming 3 percent annual inflation. So how do you get to $2.3 million? "Assuming a starting account value of $50,000 and an 8 percent return on assets, an investor would need to deposit $13,500 at the beginning of each year over the next 30 years to achieve that result," says Andrew Gluck, managing director of wealth management at GCG Financial.
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