Do You Need $1 Million for Retirement?
By Rick Schramm
Senior Vice President, Commercial Lending, NMLS #662906
Reality is, you will likely need the $1 million portfolio. In his book, You Can Retire Sooner Than You Think, Wes Moss outlines the $1,000 per Month Rule. The rule is this: For every $1,000 per month you want to have at your disposal in retirement, you need to invest $240,000. These investments will supplement Social Security and any pension or part-time work in retirement.
Consider why $240,000 in investments equals $1,000 a month:
- $240,000 x 5% (annual withdrawal rate) = $12,000
- $12,000 divided by 12 months = $1,000 per month
The 5% annual withdrawal rate will provide monthly income for more than 20 years.
But How Do You Save $1 Million?
To accumulate $1 million, you should consider investing in growth assets (cash, stocks, bonds, and mutual funds). The $1 million excludes assets such as the value of a home and vehicles.
Based on the example above, a $1 million portfolio of investments will provide a $50,000 annual supplement ($4,166 per month) to your social security, pension, or part-time retirement income. [$1,000,000 x 5% = $50,000; $50,000/12=$4,166]
If you are contemplating early retirement, you should consider accumulating $300,000 for every $1,000 per month you want at your disposal in retirement. This will permit a 4% withdrawal rate (monthly income for more than 25 years).
So, how can you create a $1 million portfolio of growth assets?
While the power of compounding (return on your investments) will give you some assistance, the key is saving money and correctly structuring your financial statement.
You’ll need to:
- Live on less than your household income – try to save at least 15% of your gross household income. The easiest way to save is auto deduct (have it automatically taken out of your pay).
- Start early, don’t procrastinate! If a 22-year-old invests $4,000 per year for eight consecutive years and you assume an annual return of 7.2%, the $32,000 investment grows to $505,000 by age 65. However, if the same person waits 8 years and begins investing at age 30, that same $32,000 only grows to $290,000. Eight years of not investing costs $215,000.
- Limit debt to only your mortgage (no credit card or vehicle/boat debt).
- Be conservative when purchasing a home– a large mortgage payment limits your ability to create growth assets, as it consumes dollars that are better allocated to equities/mutual funds. (Their historical return far exceeds the return on a residence).
- Take advantage of what the tax code gives you by participating in a Health Savings Account, Flexible Spending Account, 401K, IRA, and Roth IRA. You want to maximize tax-deferred savings.
- Allocate a large percent of your investing to stock mutual funds (preferably a low-cost index fund that replicates the S&P 500). While there are risks, historically the risk has been well rewarded.
Things You’ll Want To Avoid:
- Purchasing assets that don’t produce income and need to be financially maintained (drains income) – vacant land, boat, horse, etc.
- Thinking you are a better investor than the market. Some people don’t participate in their employers 401K because they want to be in control of their money, don’t like the investment options provided, or don’t trust their employer.
- Being sensitive to political and social concerns. Presidents continue to be elected every four years. Global terrorism is, unfortunately, the new norm. Recessions come and go. As a long-term investor, these issues mean little or nothing to your financial success.
- Procrastinating – there are many excuses people use: the market is at a record high/low, I won’t be with this employer that long, etc.
- Not maximizing your employer’s 401K contribution. If you aren’t saving a minimum of what your employer will match, you are leaving money on the table. Their gift to you has real value that you need to capture.
- Taking a short-term view to investing. If you purchase individual stocks, you have to be correct twice – the price at which you purchase and the price at which you sell. While stocks need to be a large percent of your growth assets, it is preferable to buy the market (low-cost S&P 500 stock index fund). Why bet on one horse, when you can bet on the whole field?
While creating a $1 million investment portfolio sounds like a daunting task, you can do it during your working career. However, it takes planning and discipline.