Source: Getty Images How to get to $1 million
Not surprisingly, the most common retirement savings goal among Americans is $1 million. Unfortunately, many people who want to retire as millionaires have no idea how to get there. With that in mind, here are six steps to take if you'd like to retire with a seven-figure nest egg.
Source: Getty Images 1. Open a retirement account
Technically, you can save and invest money in any brokerage account. However, if you choose a tax-advantaged retirement account, it greatly increases the compounding power of your money and makes getting to a million (or whatever your goal is) much easier. For most people, this means an individual retirement account
https://www.fool.com/knowledge-center/what-is-an-ira.aspx
, or IRA.These accounts are an important part of any retirement saving strategy because their tax advantages can be incredibly valuable over time. Traditional IRA and most 401(k) contributions can be deducted from your taxable income, while Roth IRA and 401(k) withdrawals in retirement will be completely tax-free. In all cases, your money is allowed to grow tax-deferred over time.
If you have a 401(k) or similar retirement plan at work, this step is already done for you. Nonetheless, there are some advantages to using an IRA, such as the ability to withdraw money penalty-free to help cover college costs for your kids.
Opening an IRA is usually a quick and easy process. IRAs come in two major varieties -- traditional and Roth -- both of which have their own advantages. Learn more about the pros and cons of these two options here.
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Source: Getty Images 2. Learn how to allocate your investments
The term "asset allocation" refers to the percentage of your investment money that you invest in different assets -- namely, stocks and fixed-income investments such as bonds.
As a rule of thumb, by taking your age and subtracting it from 110, you can determine the approximate percentage of your investment portfolio that should be in stocks, with the rest allocated to bonds. For example, if you're 35, the formula suggests that you invest 75% of your money in stocks and 25% in bonds. It's important to periodically adjust your portfolio so you maintain the right asset allocation. As you get older and focus more on preserving your wealth, rather than growing it, you'll gradually shift more money out of stocks and into bonds.
ALSO READ: How to Pick the Best Asset Allocation for You
Source: Getty Images 3. Choose Your Investments Wisely
If you're investing through a 401(k), you're limited to the basket of investment funds offered by your plan administrator. I can't tell you exactly what the best choices are without knowing what you have to choose from, but you should invest in a selection of low-fee stock and bond funds that meet your target asset allocation.
As an example, a 35-year-old may choose to allocate his or her 401(k) in this way:
45% in an S&P 500 or "total stock market" fund 15% in a small-cap stock fund 15% in foreign stocks or emerging markets 15% in a total bond market fund 10% in an inflation-protected (TIPS) bond fundOf course, this is just one possible example, and there are plenty of good combinations that will serve you well.
If you invest through an IRA, meanwhile, you can choose from thousands of different investments (one of the advantages of IRA investing). You can choose any stocks, bonds, mutual funds, or ETFs you want. To be clear, buying individual stocks -- especially as a retirement investment -- isn't right for everyone. Unless you have the time, knowledge, and desire to research and evaluate stocks, you're probably better off using a mutual fund or ETF strategy similar to the one I described for 401(k) investors.
Source: Getty Images 4. Know what to realistically expect from your investments
It's impossible to predict the total returns (i.e., dividends plus price appreciation) you'll get from your stock and bond investments over short time periods. However, over the long run, investment performance can be surprisingly predictable.
Stocks generally return about 9% to 10% per year over long time periods, and bonds tend to average 4% to 5%. So, for a properly allocated portfolio, it's reasonable to expect overall annualized returns of about 7% over a period of several decades.
Source: Getty Images 5. Save enough to reach $1 million
Based on an expected return rate of 7%, the other variable that determines how much your portfolio will grow is time. In other words, if you have 20 years until retirement, it will require much bigger investments to achieve a $1 million goal than it would if you had 30 or more years.
With that in mind, here's a quick guide to help you approximate the amount you'll need to save and invest per month in order to reach your $1 million savings goal. These figures assume you're starting with no money in savings, so if you've already started, your monthly savings requirement could be significantly less.
If you are...
10 years away from your desired retirement date, you would need to save $5,378 each month to reach $1 million by retirement 15 years away from retirement, you'd need to save $2,738 each month to reach $1 million 20 years away, you'd need to save $1,544 each month 25 years away, you'd need to save $916 30 years away, you'd need to save $558 35 years away, you'd only need to save $505 each month to reach $1 million by retirementFigures assume 7% long-term investment returns.
The takeaway: The easiest way to save a million dollars is to start as soon as possible.
ALSO READ: You May Be Closer to $1 Million Than You Realize
Source: Getty Images 6. Will $1 million be enough?
As a final point, it's important to mention that $1 million might not be enough for a comfortable retirement, especially if you're decades away from retiring.
First, keep in mind that all of the figures in this article are in today's (uninflated) dollars. A million dollars in 30 years will not have the same purchasing power as it does today. In fact, based on historical inflation rates, $1 million in 30 years will be the equivalent of just over $400,000 in 2017, in terms of purchasing power.
Second, the widely used 4% rule of retirement says that you can safely withdraw 4% of your savings during your first year of retirement, and increase your withdrawals in subsequent years to keep up with inflation, without fear of running out of money. The idea is that over time, your investment returns will help counteract, or even reverse, the withdrawals you make.
However, if you withdraw 4% of $1 million each year, you'll only get $25,000 in annual income from your savings. Even when factoring in Social Security, will that be enough?
It's certainly good to have a concrete savings goal like $1 million, but it's also important to accurately assess your "retirement number" -- that is, how much you'll really need to retire comfortably.
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