I just came across an article on Seeking Alpha about a 45-year old who had recently retired after accumulating a portfolio of about $1M. Most people don't want to retire in their 40s or 50s unless they absolutely hate their job - and even then, they might just prefer to do something different, not quit altogether. On the surface, a life without work commitments sounds exciting and liberating, but there's only so much golf you can play and there are enough hours in the day for your family even after the daily grind.
No, I read the article differently: The investor was able to accumulate $1M through disciplined saving and investing by his mid-40s. That's what I call a job well done and, I imagine, is a more common and realistic goal for most people. But what if you're about 45 today, have nothing saved and secretly read that article with jealously and resentment? Fear not, you aren't a complete lost cause. I can give you three basic principles that you could begin following today which very well may, by the time you reach retirement, push you over the million-dollar asset mark.
#1-You Have To Embrace Time
If you think you are going to get to $1M overnight, you're sadly mistaken. Think of it this way: If you are in your mid-40s with almost nothing put away for retirement, you didn't get this way overnight. You made conscious or unconscious decisions for years (decades?) to consume and not save. Or maybe you did save and invest and it turned out terribly. Maybe an unfortunate divorce took a big bite out of your savings. Whatever the cause, it's taken time to get here and it will take time to get out. Don't look back, start looking forward.
Right now, we consider "full retirement age" to be 65 in this country. And while that may be pushed back a few years in the near future, it's a rough number we can work with. It represents two full decades where you can get serious and get to work on accumulating some meaningful wealth that should support you for the rest of your life.
Knowing you have time is crucial to our second principle, because it eases your mind during the inevitable short-term periods when things are not going as planned.
#2-You Have To Be Disciplined
I'm not going to lie: It's going to take a ton of discipline to get you over the $1M threshold. What do I mean by discipline?
First, you're gonna have to stop spending all your income. I figure you need to start putting aside $1,500 per month into an investment account, or $18,000 per year. And every year, you'll need to give your retirement savings rate a raise: Start with inflation, or about 3% per year.
That might sound like a lot, but if you're lucky, you have a 401(k) plan that includes an employer match, so not all of this savings needs to be yours. Or maybe you're fortunate enough to work for a company with a lucrative profit sharing plan. I've seen (for a plan I manage, for example) profit-sharing contributions add up to as much as 20% to 25% of an employee's gross salary in some years. If you don't have a great retirement plan where you work, maybe you should ask yourself how much you really value your employment there and if it's at all worthwhile moving to a better company which cares more about their employees.
Second, you have to own stocks. Only stocks. They are the only broadly available asset that has historically appreciated at the rate necessary to transform your monthly savings into serious long-term wealth, which is about 10% annually (the return on the S&P 500 from 1926-2015). But there are downsides to this handsome historical appreciation: This return has included several serious bear markets where share prices fell by 40% (1973-1974 and 2000-2002), 50% (2008) and as much as 80% (1929-1932). You have to have the discipline to keep investing, month in and month out, even if stocks are dropping in value.
How can you do this? Remember one simple thing: Temporary drops in stock prices (all declines have historically been temporary) provide you with a better buying opportunity. Lower share prices mean you can buy more shares at temporarily depressed prices, and most likely your future returns on these purchases will be even higher than long-term averages. Said differently, in savings mode, you aren't hoping for consistently high returns on stocks. You're rooting for bear markets from time to time and only that stocks eventually produce the long-term returns for you that they have historically.
Time and discipline, by the way, are about 80% of what you need in order to be successful. And I say this because the latter principle is a major hurdle for most people. As investors, we find it next to impossible to defer instant gratification for savings that we may one day benefit from, at some future point we can barely dream of. And when we're losing money on our savings that we don't get to spend today, that's just rock salt in a major wound. It's often enough to cause people to throw in the towel completely.
There is another 20% or so, and I'll conclude with that next. But start with time and discipline and master those first. Principle #3 is meaningless without #1 and #2.
#3-Intelligent Investing and Good Fortune
So what are you going to do with that big chunk of monthly income you don't get to spend anymore? Here's what you aren't going to do: Don't buy individual stocks. Don't hunt down a mutual fund manager with a great track record. Don't subscribe to investment newsletters or listen to a single piece of "advice" you hear on CNBC.
If you want to keep it simple, put about $1,000 per month into an S&P 500 index fund ((MUTF:VFINX), (NYSEARCA:SPY)) and the other $500 into an international stock index fund ((NYSEARCA:EFA), (MUTF:VGTSX)). Every month. At the end of the year, figure out how much you have in each and rebalance them back to about 70% S&P 500 and 30% international. That's it.
If it were me, I'd go one step further. For US stocks, I would include asset class mutual funds that own large and small value stocks (for example, DFA US Large Value (MUTF:DFLVX), and DFA US Small Value (MUTF:DFSVX). In international markets, I wouldn't use the index at all; I'd buy asset class mutual funds that own international large and small value stocks (for example, DFA Int'l Value (MUTF:DFIVX) and DFA Int'l Small Value (MUTF:DISVX). For what it's worth, this is exactly what I do in my own personal retirement portfolio (I don't own the Vanguard S&P 500 fund, but instead the DFA US Large Cap Equity fund (MUTF:DUSQX)).
When we look at these two approaches over the last 20 years (see here), we find that the first earned about 7% annually and got you pretty darn close to your goal - ending with $846,239. The second returned about 2% per year more, thanks to the added benefits of smaller and more value-oriented stocks, and resulted in $1,026,965. Jackpot.
Now, for these results to repeat, you'll need a bit of good fortune in the returns department. We don't know for sure what future returns on stocks will be. You'll need about a 9% return for your $1M goal to be attainable. As the last 20 years show, not all stocks are a sure bet to produce this result, even if it is in line with long-term averages. That's why I advocate owning smaller and more value-oriented stocks along with a broad-market index fund. These companies have a rich history of achieving higher-than-market returns, tend to offer diversification benefits during periods where broad indexes are floundering (like the 2000-2009 "Lost Decade"), and their slightly higher volatility further aids when you are dollar-cost-averaging.
That's it. There's no more magic or silver bullets. No compelling stock picks or market-timing schemes. You don't need them even if they did work, which they don't. As a matter of fact, the number of times you avoid giving into the temptation to sink your savings into these scams is directly related to the likelihood you'll be successful in achieving your long-term goals. So get to work. I've laid out three broad principles anyone can begin to follow. It won't be easy. But it's doable. Stop procrastinating and start saving and investing the right way.
Past performance is not a guarantee of future results. Index and mutual fund performance shown includes reinvestment of dividends and other earnings but does not reflect the deduction of investment advisory fees or other expenses except where noted. This content is provided for informational purposes and is not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services.
Disclosure: I am/we are long DUSQX, DFLVX, DFSVX, DFIVX, DISVX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.