Seeking Alpha

How To Save $1.5 Million Starting At 40

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Includes: AMT, ASML, AVGO, BA, BLL, CCI, CHTR, CVS, D, DWX, FB, HD, IQV, ITW, JD, JNJ, KEYS, LMT, LULU, LYB, MA, MAIN, MKTX, MMM, MO, MSFT, NTES, O, PEP, PG, PRU, PYPL, T, TDG, TMUS, TSN, TXN, UL, UPS, V, VLO, VTR, WBA, WDAY, WFC, XOM
by: Financially Free Investor
Summary

Let’s say you just turned 40. It's high time to have a financial plan, discipline, and unwavering determination to be able to retire comfortably.

Fortunately, you have 20 years or more to save and compound. The length of time that your savings can compound generally has a greater impact than the actual savings.

We will provide three strategies that can be combined with modest savings or no savings, starting at 40 to accumulate a significant wealth safely by age 62.

Let's say you just turned 40. Turning 40-years-old is a milestone in itself. Welcome to the middle age! But on the positive side, you are more mature, financially savvy, and more than likely well settled in your career. You also have a much greater income level than when you just started. Unfortunately, prior to 40, a vast majority of people can't see retirement savings as an important goal and don't pay much attention that it deserves. In the early years and even in the 30s, the thought of retirement appears to be so distant and elusive that so many people fail to save for it. It goes without saying that saving and investing at a younger age goes a long way in meeting retirement goals without stress. Only if we all could get this wisdom in our 20s or 30s, but it does not happen to a vast majority of us.

Even if you are close to 50 or if you have not saved much for retirement, this article could still be of interest to you. This article also is for folks of any age group, who may be looking for a multi-faceted investment approach, which is conservative, relatively safe, and income producing.

Importance of Starting Early

We cannot emphasize enough about the importance of starting saving early. Earlier you start saving, better it is. However, most of us do not have this wisdom at the age of 25. Just for the sake of illustration, we will show an example of how time and compounding can play such an important role. Two friends John and Jim started working in their full-time jobs at the age of 25 at the end of the year 1981. They both retired at age 62 by the end of the year 2018. Let’s also assume that they both had similar jobs and similar incomes. John started saving and investing right from day 1 by putting aside $250 a month in his investment account. He also increased the rate of his savings by 3% every year. By saving and investing this modest amount every month, and assuming all his savings were invested in S&P 500 index fund (through out the period of 37 years), John would have a balance of over $1.2 million by the age of 62 at the end of the year 2018.

Jim did not see the importance of saving and investing at a young age and did not have this sense of urgency until he got to 40 years of age. Let's see how much Jim needed to save every month (starting at 40) to match John’s retirement balance by the age of 62.

Table-1 (below): Starting at age 25, saving $250 every month and increasing it by 3% every year, John hits the target of approximately $1.2 million at age 62.

Table-1:

Age

Year

S&P500 Annual Return

Monthly Saving

Annual Saving

Starting Capital

Growth

Ending Balance

25

26

1982

23.09%

250

3,000

0

0

$3,000

27

1983

15.32%

258

3,090

3,000

459

$6,549

28

1984

3.13%

265

3,183

6,549

205

$9,937

29

1985

21.33%

273

3,278

9,937

2,120

$15,335

30

1986

18.06%

281

3,377

15,335

2,769

$21,480

31

1987

4.71%

290

3,478

21,480

1,012

$25,970

32

1988

16.22%

299

3,582

25,970

4,212

$33,765

33

1989

31.36%

307

3,690

33,765

10,589

$48,043

34

1990

-3.32%

317

3,800

48,043

-1,595

$50,248

35

1991

30.22%

326

3,914

50,248

15,185

$69,347

36

1992

7.42%

336

4,032

69,347

5,146

$78,525

37

1993

9.89%

346

4,153

78,525

7,766

$90,443

38

1994

1.18%

356

4,277

90,443

1,067

$95,788

39

1995

37.45%

367

4,406

95,788

35,873

$136,066

40

1996

22.88%

378

4,538

136,066

31,132

$171,736

41

1997

33.19%

389

4,674

171,736

56,999

$233,409

42

1998

28.62%

401

4,814

233,409

66,802

$305,024

43

1999

21.07%

413

4,959

305,024

64,269

$374,251

44

2000

-9.06%

426

5,107

374,251

-33,907

$345,452

45

2001

-12.02%

438

5,261

345,452

-41,523

$309,189

46

2002

-22.15%

452

5,418

309,189

-68,485

$246,122

47

2003

28.50%

465

5,581

246,122

70,145

$321,847

48

2004

10.74%

479

5,748

321,847

34,566

$362,162

49

2005

4.77%

493

5,921

362,162

17,275

$385,358

50

2006

15.64%

508

6,098

385,358

60,270

$451,726

51

2007

5.39%

523

6,281

451,726

24,348

$482,356

52

2008

-37.02%

539

6,470

482,356

-178,568

$310,257

53

2009

26.49%

555

6,664

310,257

82,187

$399,109

54

2010

14.91%

572

6,864

399,109

59,507

$465,479

55

2011

1.97%

589

7,070

465,479

9,170

$481,719

56

2012

15.82%

607

7,282

481,719

76,208

$565,209

57

2013

32.18%

625

7,500

565,209

181,884

$754,593

58

2014

13.51%

644

7,725

754,593

101,946

$864,264

59

2015

1.25%

663

7,957

864,264

10,803

$883,024

60

2016

11.82%

683

8,196

883,024

104,373

$995,594

61

2017

21.67%

703

8,442

995,594

215,745

$1,219,780

62

2018

-4.52%

725

8,695

1,219,780

-55,134

$1,173,341

Table-2 (below): Jim started saving at age 40 with no prior savings. To be able to achieve a $1.2 million target (same as John) while starting at age 40. Jim must save $1,450 every month starting age 40 and increase it by 3% every year. At this age, John was only contributing $389 a month. So, Jim must start with as much as 3.7x of John contributions. In the year 2018 (the last year prior to retirement), John was contributing $725 a month, while Jim needed to contribute $2,697 a month to end with the same total as John.

Table-2:

Ending Age

Year

S&P500 Annual Return

Monthly Saving

Annual Saving

Starting Capital

Growth

Ending Balance

40

1996

22.88%

0

0

0

0

$0

41

1997

33.19%

1,450

17,400

0

0

$17,400

42

1998

28.62%

1,494

17,922

17,400

4,980

$40,302

43

1999

21.07%

1,538

18,460

40,302

8,492

$67,253

44

2000

-9.06%

1,584

19,013

67,253

-6,093

$80,173

45

2001

-12.02%

1,632

19,584

80,173

-9,637

$90,120

46

2002

-22.15%

1,681

20,171

90,120

-19,962

$90,330

47

2003

28.50%

1,731

20,777

90,330

25,744

$136,851

48

2004

10.74%

1,783

21,400

136,851

14,698

$172,948

49

2005

4.77%

1,837

22,042

172,948

8,250

$203,240

50

2006

15.64%

1,892

22,703

203,240

31,787

$257,730

51

2007

5.39%

1,949

23,384

257,730

13,892

$295,005

52

2008

-37.02%

2,007

24,086

295,005

-109,211

$209,880

53

2009

26.49%

2,067

24,808

209,880

55,597

$290,285

54

2010

14.91%

2,129

25,552

290,285

43,282

$359,119

55

2011

1.97%

2,193

26,319

359,119

7,075

$392,513

56

2012

15.82%

2,259

27,109

392,513

62,096

$481,717

57

2013

32.18%

2,327

27,922

481,717

155,017

$664,656

58

2014

13.51%

2,397

28,760

664,656

89,795

$783,211

59

2015

1.25%

2,469

29,622

783,211

9,790

$822,623

60

2016

11.82%

2,543

30,511

822,623

97,234

$950,368

61

2017

21.67%

2,619

31,426

950,368

205,945

$1,187,739

62

2018

-4.52%

2,697

32,369

1,187,739

-53,686

$1,166,422

We recognize that many readers would have an issue with investing the entire savings in the S&P 500 index for a period of 37 years. But this was just an example to illustrate that the more you delay the savings, the harder it gets to reach the goals. The length of time that your savings can compound generally has a greater impact than the actual savings.

It's important to note that if we are starting in 2019, the purchasing power of $1.2 million after 37 years would not be the same as it is today. So, a 25-year-old today should probably aim for 2.5x of that amount, or as much as $3 million to retain the similar purchasing power as of $1.2 million today (assuming an average rate of inflation at 2.5% for the next 37 years). That means if John was starting today, he would probably need to put aside $600-$650 a month and increase it by 3% every year to achieve $3 million after 37 years.

You just turned 40; What to do now?

Let's consider two scenarios:

  1. Let's assume you have not saved much or any significant sums until you got to 40. However, there's no need to panic - you still have plenty of choices. Time is still on your side. All you need is a strong determination to save more now and invest wisely to get at least 7% (preferably 8%) average yearly returns. In this scenario, to reach your goal of $1.5 million, you will need to save much more aggressively, maybe as much as 13%-15% of your gross family income, assuming 100,000 of family income. Just like anything new, it will be difficult in the beginning. There's always a period of adjustment. What you need is unwavering determination. Once you have followed your saving routine for a year or two, it becomes more of a habit and sometimes little addictive.
  2. You already have saved a significant sum by age 40, let’s say $100,000, somewhat similar to John in the example above. You recognize that $1 million will not be same after 22 years, so your target needs to be higher, maybe $1.5 million (or more). The second part is to invest wisely to get at least 8% average yearly returns. Since you are starting with significant savings, to reach your goal of $1.5 million by age 62, all you need is to save 6% of your gross family income (assuming 100,000 of family income). However, it will be recommended to save at least 8% of your gross family income to cover for any shortfalls. In the end, if you happen to overshoot your target, it will be a pleasant surprise and nothing to worry about.

Scenario-1:

Assumptions:

Age

40 years

Current savings

$100,000 in tax-deferred retirement accounts,

$20,000 in emergency cash.

Current annual gross family income

$100,000

Future savings rate

6% ($6,000 a year, increase 3% every year), preferably 8%

Employer's match in 401K

80% on first 6% ($4,800 a year)

Total savings per year

$10,800 (inclusive of employer's match)

Yearly growth-rate from investments

8%

Target Goal at age 62

$1.5 million

Note: Even though we have used 6% savings rate in the example below, we highly recommend 8% or more to cover for any shortfall in growth/returns. We will discuss how to achieve 8% growth in the next section of this article.

Table-3:

Scenario-2:

Assumptions:

Age

40 years

Current savings

None in tax-deferred retirement accounts,

$20,000 in emergency cash.

Current annual gross family income

$100,000

Future savings rate

13% ($13,000 a year, increase 3% every year), preferably 15%

Employer's match in 401K

80% on first 6% ($4,800 a year)

Total savings per year

$17,800 (incl. of employer's match)

Yearly growth-rate from investments

8%

Target Goal at age 62

$1.5 million

Note: Even though we have used 13% savings rate in the example below, we highly recommend 15% or more to cover for any shortfall in growth/returns. We will discuss how to achieve 8% growth in the next section of this article.

Table-4:

Portfolio Construction:

(How to get an average of 8% or more yearly return)

You not only have to grow your capital at 8% or more annually, but at the same time, it's also important to conserve the savings. That means we want to invest in a way that our portfolio volatility is low and we avoid taking big losses along the way. To achieve these objectives, we like to invest in multiple strategies using the concept of buckets (or baskets). This helps not only in providing diversification but also provides some level of hedge during the times of market stress. Even though investing has become very easy for ordinary folks by way of online brokerage accounts, low commissions, and online research resources. However, on the other hand, investing successfully and growing money has never been easy, and it's not so today. Depending solely on index investing may turn out to be risky, volatile, and bumpy, especially when the index investing has been so successful in the past decade. That's why, in our view, it's important that we employ a multi-strategy approach.

For the purpose of this portfolio construction, we will use three investment buckets:

  1. DGI portfolio -> 35-40% of assets
  2. Risk-Adjusted Rotation Portfolio (401K/IRA accounts) -> 35-40% of assets
  3. High-Growth Portfolio -> 20-25% of assets.

Bucket 1: DGI Portfolio (35-45% of Assets)

This bucket could be implemented inside your IRA/ROTH-IRA or taxable-brokerage accounts. If you are solely investing in a 401(k) type of account, which is managed by your employer (or employer-sponsored fund company), it may or may not allow investment in individual stocks. However, many of the large employers have contracted this out to companies like Fidelity, which in turn allow investing a certain portion of your assets in individual stocks in a brokerage type account.

One could select 20-30 large, blue-chip companies with a solid history of paying and growing dividends. Since we are designing this for a 40-year old, we should include some companies that may have low current yield but high growth rates of dividend, for example, Mastercard (NYSE:MA), Home Depot (NYSE:HD), Boeing (NYSE:BA) and Texas Instruments (NASDAQ:TXN). An overall yield of 3% for the portfolio should suffice, which would grow to at least 6%-8% yield on cost in the next 20 years.

Below, we provide a sample selection of 25 stocks (sorted on sector/industry) for illustration purposes. The average current yield is 3.57%. We assume that the dividends will be re-invested either in the original stocks or in new stocks.

Table-5:

Symbol

Company Name

Sector/Industry

Yield (09/10/2019)

BA

Boeing Co (BA)

Aerospace

2.28%

UPS

United Parcel Service (UPS)

Air & Freight Services

3.16%

MAIN

Main Street Capital (MAIN)

BDC

6.00%

PEP

PepsiCo (PEP)

Beverages

2.80%

LYB

LyondellBasell Industries (LYB)

Chemicals

5.16%

UL

Unilever (UL)

Consumer Staples

2.92%

PG

Procter & Gamble Co (PG)

Consumer Staples

2.44%

LMT

Lockheed Martin (LMT)

Defense

2.31%

XOM

Exxon Mobil (XOM)

Energy

4.87%

VLO

Valero Energy Corp. (VLO)

Energy/Refinery

4.54%

WFC

Well Fargo (WFC)

Financials

4.21%

V

Visa Inc. (V)

Financials

0.55%

PRU

Prudential Financial, Inc. (PRU)

Financials - Insurance

4.75%

TSN

Tyson Foods, Inc. (TSN)

Food/Farm Products

1.80%

JNJ

Johnson & Johnson (JNJ)

Healthcare/Drugs

2.96%

HD

Home Depot (HD)

Home Improvement Stores

2.34%

MMM

3M Company (MMM)

Industrial

3.47%

DWX

S&P International ETF (DWX)

International ETF

4.12%

O

Realty Company (O)

REIT

3.61%

WBA

Walgreens Boots Alliance, Inc (WBA)

Retail/Pharmaceutical

3.29%

TXN

Texas Instruments Inc (TXN)

Tech/ Semiconductor

2.42%

MSFT

Microsoft (MSFT)

Technology

1.32%

T

AT&T (T)

Telecom

5.54%

MO

Altria Group (MO)

Tobacco

7.63%

D

Dominion (D)

Utility

4.79%

TOTAL/ AVERAGE

3.57%

Bucket 2: 401K/IRA Account Strategy (Roughly 35-40% of Assets)

At age 40, much of your savings (or future savings) may be tied to your employer-sponsored 401K plan. Some of the 401K plans offer only a few mutual funds or ETFs. Fortunately, most of them offer at least some funds that represent the broad market indexes like S&P 500 as well as funds from different categories like large-cap, mid and small cap, international, and emerging markets. Keeping this in mind, we will suggest two options, though we prefer the second option.

Option 1: Buy-and-Hold portfolio:

A buy-and-hold type of portfolio is not necessarily bad for a 40-year old since he/she would have at least 20 years before retirement to smooth out the returns. Moreover, they would be automatically making contributions every paycheck, mostly every two weeks or twice a month. This ensures automatic dollar-cost averaging. The dollar-cost average approach can be very helpful for a 20-year time horizon because you would be buying in good times as well as bad, which means you would be buying at high as well as low prices. But the key requirement is that one must follow the discipline. The biggest advantage of such a portfolio is that this is essentially a set-and-forget kind of portfolio and can be left on auto-pilot, except maybe some rebalancing on an annual basis. If this is what one prefers, the following type of allocation should work on a long-term basis. The below allocations can be suitably adjusted as one grows older.

  • 35% Large-Cap Domestic stock fund
  • 20% Mid- and Small-Cap Domestic stock fund
  • 15% International Developed Markets fund
  • 10% Emerging markets fund
  • 20% Bond and/or Treasuries fund

Option 2: Risk-Adjusted Rotational approach:

The above method (option 1) is not bad if you were a long-term and patient investor. But let’s face it, not every investor is capable of tolerating large drawdowns that occur from time to time, and they may panic just at the very wrong time. Besides, we should add that high volatility and large drawdowns can do a lot of harm to near retirees. As an alternative to option-1, which has no downside protection, one could implement a risk-adjusted, rotation-based strategy. This kind of portfolio is designed to capture the majority of the growth during good times and reduce the drawdowns by at least 50% during bad times as well as reduce volatility at the same time. In other words, they provide far less volatility and drawdowns, which results in higher growth. Fortunately, this kind of portfolio can be very easily implemented inside a traditional 401(k) account or IRA accounts.

This strategy would rotate between S&P 500 fund and the Treasury/bond funds. When the market is relatively strong and less volatile, the more funds get invested in the stocks (S&P 500). However, when the market starts declining and gets more volatile, more of the funds get switched to Treasuries and/or bonds. In the example below, we are using volatility to adjust allocation to the S&P 500 and Treasuries on a monthly basis. Higher the volatility, we will allocate less to stocks and more to Treasuries and so on. Such a portfolio may underperform the broader market slightly during very strong bull markets but will protect the capital during major corrections or recessions. This example below assumes monthly switch. There can be many such strategies or variations that could be adopted.

Author's Note: This strategy (Risk-Adjusted Rotation IRA portfolio) is similar to a strategy that is part of our Marketplace service "High Income DIY Portfolios."

The benefits of such a strategy over long periods are clearly visible from the below chart. It provided slightly higher returns than the S&P 500 but without the bumpy ride:

Bucket 3: High-Growth Portfolio (15%-25% of Assets)

This option is definitely more desirable at a younger age to provide high growth, although it does come with higher risks, so allocation should be gradually reduced as the investor grows older and approaches retirement.

But we consider 40 years of age as still young enough to include a high growth strategy at least for the next 10 years. Once you get to 50 or early 50s, you could gradually reduce the exposure to a high-growth strategy and move these funds to another strategy that may be a bit more conservative.

This bucket will essentially invest in high growth areas of the economy, for example, technology, financials, healthcare, and biotechnology. The problem is that something that's high growth today may not be so after two years. So, this kind of portfolio will require at least yearly management.

Every year in January (or any other month you may choose, but keep the same month from year to year) run a stock screener to filter top 10 growth stocks that meet the following criteria:

Member of S&P 500, DJIA or Nasdaq 100 indexes market cap at least $10 Billion or more revenue growth during the last three years was > 10% total return over the last 12 months, > 15-20% the projected Forward EPS growth for the next three years, > 10% select no more than three stocks from the same sector/industry.

Buy 10 stocks in equal proportions at the beginning of the year and keep them for the year. Repeat the selection process every year. Many of the names from the previous year will make to the subsequent year, but we expect a few of them to drop out from one year to next and replaced by new names. This strategy will require some work on a yearly basis. Most years, this strategy will provide good results unless we are in a bear market. However, the downside is that there's no protection mechanism from market downturns or recession-like situations. If you could tolerate large drawdowns in this bucket, the strategy may be suitable for you. So, please know your situation and risk tolerance. Further, we do not have any back-testing results to support this strategy.

We ran this screener as on 09/10/2019 - we got about 37 names. Here are the top 20 stocks (sorted on the highest three-year expected EPS growth).

Symbol

Company Name

Price (09/10/2019)

(52 Weeks) %

Growth (3 Yrs)

Forward EPS Long Term Growth (3-5 Yrs)

Market Capitalization

P/E (Price/TTM Earnings)

Headquarters

(JD)

JD.com Inc

30.74

16.81

33.89

61.61

$45.93B

51.2

China

(CHTR)

Charter Communications Inc

422.65

37.55

64.77

46.27

$92.97B

71.6

USA

(WDAY)

Workday Inc

172.89

18.02

34.41

28.53

$39.00B

--

USA

(FB)

Facebook Inc

187.13

15.78

46.04

22.18

$538.72B

31.7

USA

(AMT)

American Tower Corp

217.2

52.85

14.20

21.65

$99.09B

65.6

USA

(CCI)

Crown Castle International Corp

139.77

26.95

13.96

21.00

$59.69B

81.3

USA

(ASML)

ASML Holding NV

241.03

33.43

22.43

19.60

$101.63B

39.3

Netherlands

(PYPL)

PayPal Holdings Inc

103.22

18.70

18.66

19.29

$124.09B

49.2

USA

(TMUS)

T-Mobile US Inc

78.29

22.89

10.49

18.90

$67.61B

20.5

USA

(KEYS)

Keysight Technologies Inc

97.81

50.24

10.73

18.80

$18.49B

60.4

USA

(LULU)

Lululemon Athletica inc

193

28.89

16.86

18.70

$25.33B

47.7

Canada

(NTES)

Netease Inc

272.5

44.99

40.50

18.22

$35.87B

28.1

China

(MA)

Mastercard Inc

274.92

34.24

15.64

16.86

$287.89B

42.4

USA

(AVGO)

Broadcom Inc

293

25.81

45.10

16.10

$116.75B

36

USA

(TDG)

TransDigm Group Inc

503.7

54.70

12.08

15.85

$27.37B

37.7

USA

(V)

Visa Inc

175.96

26.78

14.08

15.80

$394.87B

33.8

USA

(BLL)

Ball Corp

72.23

76.97

13.31

15.26

$24.91B

47.2

USA

(MKTX)

MarketAxess Holdings Inc

346.26

97.74

13.37

14.90

$13.96B

70.8

USA

(MSFT)

Microsoft Corp

136.04

27.09

13.83

14.53

$1.05T

26.9

USA

(IQV)

Iqvia Holdings Inc

149.84

19.56

21.97

14.40

$29.74B

122.8

USA

Conclusion

In this article, we have focused our emphasis on folks who already are 40 or nearing 40 but haven't given much thought about the retirement savings. If you turned 40 already, it's time to be serious about saving for retirement. You cannot afford to wait any longer. Longer you wait, harder it will be to achieve your retirement goals. Compounding can do wonders to your savings, but it needs time. You need to set your retirement saving goals depending on your current income, spending needs, and other personal factors.

While saving on a regular basis is the first essential step, savings alone cannot meet retirement goals. The savings must grow on a consistent basis. In our example of a 25-year-old, saving for 37 years, contributions only accounted for about $200,000, whereas the balance $1 million came from investment growth over 37 years.

In the second part of the article, we presented three strategies to illustrate how one could construct a multi-bucket portfolio for success. Obviously, these strategies were presented just for demonstration purposes. However, one can adopt any variations of these strategies or an entirely different set of strategies. With an inflation rate of 2-3%, the average rate of growth of 8-9% is both realistic and achievable. Investments never move up or down in a straight line. Often, when one strategy zigs, another one will zag. So, it's helpful to have a multi-faceted investment approach. Not only it helps in diversification, but it also lowers the volatility of the overall portfolio.

Disclosure: I am/we are long ABT, ABBV, JNJ, PFE, NVS, NVO, CL, CLX, GIS, UL, NSRGY, PG, KHC, ADM, MO, PM, BUD, KO, PEP, D, DEA, DEO, ENB, MCD, BAC, PRU, UPS, WMT, WBA, CVS, LOW, AAPL, IBM, CSCO, MSFT, INTC, T, VZ, VOD, CVX, XOM, VLO, ABB, ITW, MMM, LMT, LYB, HCP, HTA, O, OHI, VTR, NNN, STAG, WPC, MAIN, NLY, ARCC, DNP, GOF, PCI, PDI, PFF, RFI, RNP, STK, UTF, EVT, FFC, HQH, KYN, NMZ, NBB, IIF, CHI, JPS, TLT. 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.

Additional disclosure: Disclaimer: The information presented in this article is for informational purposes only and in no way should be construed as financial advice or recommendation to buy or sell any stock. Please always do further research and do your own due diligence before making any investments. Every effort has been made to present the data/information accurately; however, the author does not claim 100% accuracy. Any stock portfolio or strategy presented here is only for demonstration purposes.