Dear Friends-

As I wrote last week, research by professors Harry Schleef and Robert Eisinger at Lewis and Clark College indicates that accumulating a million dollar-retirement stash is not as unrealistic as it sounds. The key is to have at least 70% of your money invested in stocks for 30 years. 

The other equally important factor is self-discipline. You’ve got to be prepared to stick with stocks even when times get rocky (such as the present) and to add to your portfolio every single year, if necessary. 

You must also re-balance your portfolio at the end of each year to maintain the asset allocation you selected. While a portfolio of 100% equities had the probability of success, at the minimum, you should keep at least 70% in stocks. (The lower the percentage in stocks, the more money you will have to invest each year.) 

One Way to Do It

Schleef and Eisinger looked at two different approaches. Under Method No.1, the first year’s investment was $11,000. Each following year this was increased based on the previous year’s inflation rate.

For instance, say during the first five randomly-selected years, inflation runs 3%, 2%, 4%, 5%, and 2%. Your year-end retirement contributions would be as follows:

    Year No.1: $11,300

    Year No.2: $11,556

    Year No.3: $12,018

    Year No.4: $12,619

    Year No.5: $12,871

The first thing you notice is the annual contribution goes up slightly every year. However, if your salary keeps pace with inflation, you are essentially giving your retirement contribution a “raise” in proportion to the one that you received from your employer.

While the portfolio invested 100% in stocks had an average value of $1.3 million after 30 years, the average values of the accounts with less equity and correspondingly higher bond exposure were as follows:

    90/10%: $1.2 million

    80/20%: $1.1 million

    70/30%: $992,000

Note these amounts are in what’s called “real” or inflation-adjusted dollars. That is, the amount you would have if you retired today. You’ll actually end up with significantly more in your account at the end of 30 years. However, thanks to inflation, you’ll need those extra dollars to buy the same lifestyle that a million bucks would purchase today.

Another Approach

Method No.2, is a bit more complicated for the average person because you have to calculate a target value for each of the 30 years. The amount you contribute each year is then based on how well your investments performed. 

The virtue of this approach is that is guarantees you will achieve your inflation-adjusted $1 million next egg.

If returns are worse than expected during a particular year, you have to be prepared to increase that year’s contribution. However, in blockbuster years, you might not have to contribute a dime.

The amount your contribution would vary is based upon how large a portion of your account is invested in stocks. Both your base contribution and the annual “swing”- either positive or negative- are reduced as you increase your exposure to equities. 

For instance, Schleer and Eisenger found the average annual contribution for a portfolio with an 80-20% mix of stocks-to-bonds is $11,843. In most years, this would vary by +/- $3,431. So in some years you might have to contribute $15,274, while in others, it might be as little as $8,412.

On the other hand, if your retirement account had a mix of 50-50% of stocks-to-bonds, your average annual contribution would be $15,311, with a probable swing of $4,731. Thus, years your contribution might exceed $20,000 in some years; in others, it could be $10,580.

And Now the Really Good News

If you’re truly serious about retiring with $1 million (in purchasing power) and have at least 30 years to accomplish this, just maxing out your contribution to your employer’s 401(k) plan every year will get you darn close. (The maximum 401(k) or 403(b) contribution for 2008 is $10,500.)

If your employer also contributes to your plan, that may be all you need to put you well in range.

If you don’t have a company match or aren’t covered by a retirement plan through work at all, you’ll have to do this on your own. (At least until you find a job with better benefits!) 

The first money you set aside should go into an IRA (traditional or Roth depending upon which you qualify for). The maximum base contribution this year is $5,000.

Your next option is a taxable account. This means you’ll have to contribute a bit more each year to compensate for the taxes you’ll owe on your investments. 

Mutual funds are the simplest ways to get diversified exposure to U.S. large cap stocks and U.S. corporate bonds. 

That’s it. Really.  

The hardest part will be staying committed to both your asset allocation and annual contributions. Don’t let short-term market volatility upset your long-range plans to retire a millionaire.

Hope this helps,

Gail

If you have a question for Gail Buckner and the Your $ Matters column, send them to: yourmoneymatters@gmail.com, along with your name and phone number.