How to Build a $1M Nest Egg

Dear Friends,

Got that deer-in-the-headlights feeling every time you think about how much you need to save for retirement? Relax, already! Research by two professors at Lewis and Clark College in Portland, Oreg., indicates it’s simpler than you might think to retire a millionaire.*

All it takes is about $15,000/year for 30 years. 

And a strong stomach. 

Professor Harry Schleef and colleague Robert Eisinger tested 12 different asset allocations that varied based on the amount invested in stocks vs. bonds. The goal: to test the likelihood that someone in their 30s could collect a $1 million nest egg over the next 30 years. 

In eight cases, the stock-bond mix ranged from 100%-0% (i.e. all stocks) to 30%-70%. This ratio was kept constant by re-balancing each portfolio at the end of every year. 

The four remaining portfolios started with relatively high allocations to stocks; this was gradually reduced each year in order to simulate the approach that “lifecycle” mutual funds take.  As a result, by the time the hypothetical saver in the study was ready to retire, the amount of stocks these portfolios contained was significantly lower. 

Re-defining “Risk”

The professors employed a technique called “Monte Carlo” analysis where a computer randomly selects results from the past 80 years of market returns.

“If it turns out to be 1948,” says Schleef, “we plug in the numbers for 1948.” That year’s actual returns on stocks and bonds, as well as the rate of inflation, are applied to the portfolio. Then another year is selected, and another, until you have 30 randomly-chosen years of results strung together. This process was repeated 1,000 times for each portfolio. 

While most financial analysts define “risk” in terms of how much a portfolio fluctuates in value--known as volatility in Wall Street lingo-- Schleef and Eisinger took a different approach. They decided “the real risk is the probability of failing to hit the target.” In other words, reaching retirement with a smaller nest egg than you figure you need.  

Stocks Are Key 

The first takeaway is the [more you commit to stocks, the less money you need to invest each year. Turns out, the most successful asset allocation--albeit not the most practical one for most of us--is investing 100% of your retirement dollars in equities. That’s because over the long-term, most of the “Maalox moments” the stock market delivers are to the upside. 

“The higher the percentage of equities, the higher the chance of capturing higher returns.” And, Schleef admits, low returns. However, he says, “there are enough of those high ones that outnumber the low ones.” 

Easy to say, but hard to remember when lately every day seems to usher in another “soar” or “plunge” headline about the financial markets. Schleef says while his own retirement account is almost entirely invested in stocks, he recognizes this isn’t for everyone because “there’s a psychological aspect to it.”  

It comes down to your tolerance for risk or, as Schleef puts it, “How willing are you to ride the rollercoaster? You have to realize there are going to be some peaks and valleys.”   

The good news is, “if you can’t sleep at night because your portfolio is down 10%,” Schleef and Eisinger’s research found you can reduce your equity exposure to 80% or even 70% and still have a darn good chance of achieving your target amount.  You will, however, have to increase your annual contributions. 

Keep Stock Exposure High

The second takeaway was somewhat of a surprise: Although the “conventional wisdom” is you should reduce the amount of exposure you have to equities as you approach retirement, the portfolios that held 70% or more in stocks and maintained this level for the entire 30 years had a higher probability of success. 

Furthermore, you don’t need an MBA to construct a successful portfolio--Simple works just fine. In this experiment, Schleef and Eisenger used only two assets classes: large cap U.S. stocks and corporate bonds. 

Next week: Easy steps to a million dollar retirement.

Hope this helps,

Gail

* The actual amount will be significantly higher than this; possibly around $2.5 million.  That’s because, thanks to inflation, you’ll need a lot more money in the future to buy what $1 million will purchase today.  This research takes that into account.

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.