1/12/2012 12:05 AM ET|
Can you build a $2 million 401k?
Solid returns are our only hope
Let's run some numbers to illustrate how retirements live and die based on investment returns. Yes, saving, reducing debt and controlling expenses are important. But they merely get you in the game. The big swings hinge on average annual returns.
Retirement-saving success can be boiled down to a three-way formula: You can work longer, save more of what you make or earn more on your current investments. Asset allocation -- owning stocks, bonds or something else -- is the most critical part of that equation.
Let's work a quick example: Take a 30-year-old earning $60,000 a year who has no assets and wants to retire at age 65. If our example invests in corporate bonds offering a yield of 4.5% right now, that investor would need to save 41% of his or her income to reach $2 million at retirement -- a nonstarter for most. The percentage would be higher for an older investor or for someone trying to do it using bank savings accounts paying minimal interest.
But thankfully, we are in the midst of one of those rare moments when "safe" assets such as bonds are the "risky" ones -- in the sense they have become overbought, offer yields that don't compensate for inflation and risk, and have limited potential for gains.
At the same time, stocks are coming off of their worst run since the 1930s. In the years that followed the 1930s low, the S&P 500's 10-year total return peaked at nearly 600% in 1959. Meanwhile, bonds were ravaged after the Federal Reserve used negative interest rates (as we have now) to help the government cut its World War II debts by transferring wealth, by stealth, from savers to the Treasury.
Stock market investors, on the other hand, enjoyed an average annual return of 19.4% over the period. For the sake of illustration, that 19.4% return means a 30-year-old investor could save just 1% of his or her income and still have $2 million by age 65.
Obviously, this number represents the peak 10-year return; over the long term, don't bet on it.
What should you expect? Well, the S&P 500's average annual return on a total-return basis since 1800 is around 9%. For safety's sake, I'd dial that down to 7% or 8% when doing your retirement math.
The numbers aren't necessarily pleasant to look at. At 8%, that same 30-year-old worker would have to save 19.3% of his or her income every year to hit $2 million by 65. With a 7% return, the worker would have to save 24% of income; a 9% return would mean saving 15.4%.
|What it takes to save $2 million by age 64 with $60,000 annual income|
|Starting age||Average annual return||Contribution as a % of income|
I didn't say it was easy. I said it was possible. Particularly if you consider that you'll probably get a few raises over the years. But the bottom line is that your best chance -- maybe even your only chance -- to earn these returns is in stocks and stock funds.
Yet there's no guarantee that a period of underperformance will be followed by a period of strong performance. Just look at what happened in Japan, a country that's been dealing for decades with the structural problems we now face: an aging population, persistent government budget deficits, an out-of-control national debt, stagnant growth and flat wages.
Indeed, Japan's Nikkei 225 Average is now trading at levels first reached in 1983 and is down 53% from its 2007 peak and 78% from its 1990 record high.
What lies ahead
Investors, especially those who still believe in buy-and-hold or who lack the time to actively trade, will still need healthy amounts of diligence and care as the financial world moves ever closer toward one of the two outcomes I previewed in my earlier retirement column:
- The stock market remains range-bound for another decade or more in a repeat of the 20-year stagnation of the 1960s through the 1980s, mimicking Japan's recent malaise.
- Bonds end their multidecade rise on a combination of higher inflation, a workable solution to the global sovereign debt problems and corporate leveraging, providing the raw fuel needed for another secular, long-term bull market in stocks.
The second, of course, makes that $2 million 401k look much more possible. The first makes it very tough, requiring a much more active approach to investing. In any market, some stocks do go up -- but in a rangebound market, finding them is hard work.
But we'll have no choice but to do it, if retirement is to remain within reach.
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OK, I am 41. I share a similar story to JJ. At 30 I liquidated my 401k to have a down payment to buy my first home. Big mistake.
From 30 to 41, I've managed to start over and save 250k. I too avoided the downturn by being engaged with what is going on in the world, and the markets. During the same years, my wife has done the same. Are we making a killer income? No. Do I work part time jobs? You bet.
We have posts here that say you can't do it. Total BS. Some posts say you need to live substantially below your means. Again, total BS. You mention kids cars and other things. Try having one less kid- and you have your 250K. Buy 1 less car. Try not spending money on dinners out, and your daily coffee from Starbucks, and you have your 250K. That isn't asking for much. Substantially below your means to me means you stop mowing the lawn, and painting the house. Please.
The choice is and has always been yours. But do not complain when you made it the other way, and don't ask me for my money when you go to retire. I made the hard choices, and want to keep my money for myself.
You need to work hard, and never stop educating yourself.
I'll give you a head start. Think making 7% is tough? It isn't. Enter the symbol T in quotes, and you learn that ATT pays a dividend close to 6% right now. If that dividend never grows, (Which it is) I only need ATT to go up 1% per year. GE pays close to 4%. They are recovering their dividend, and if they bring it up to where it was before the crash, you'd be getting 1.32 a share, or your 7%.
Is buy and hold dead? No. What is, is patience, and thrift, and sacrifice, and tolerance for anything but instant gratification.
Keep on lying to yourselves. The you can't do it, is only you won't do it.
Calculate it. Even if you have a 4K square foot house, and the house is paid for, taxes each year, car taxes, plates and insurance. Food. utilities bills, gas. Think about it, you will not be driving to work every day therefore less fuel for the car(s), your clothing will go down no need you not working. Now the biggest cost and you have to agree is the big health insurance. That my friend is the biggest cos to you. I do budgets everyday for people when you just sit down and think about it and you plan to have 99% of everything you one paid for before you retire, how much do you need? Social security, guess what, until they change the rules and if they did it will not effect the people who have already paid into the system, social security will be there.
Now I ma not saying to relay on that, what I am say here is simple ask yourself and all these so called planner why do you need a million dollars or even two million to retire on. Unless you are in very bad health I get it. i.e. I retired the first time at 45 could not handle it. Had nothing to do about money had more to do with Borden. second time now at 55 I retired. If need be all I would need is 2K a month and I am fine 2K at the most. This pays all my expenses and a few nights on the town each month. Travel about 8 time a years. If I live another 20 years that 480K far cry from a million dollars and I haven't even started collecting Social Security yet which by the way will be an additional 2K income a month or better.
I still work just not nearly as hard and loving it. I kind of work part time for myself which makes things easier. So if you want to sit down and know the REAL figure you will need, then hit me up from someone who has been there and have clients who are there today. The world is not as grim as people make it out to be.
Oh the market tanked, and to me that's great because in the next 15 months I would be telling to buy, look at history it will come back its just not going to bounce back as in the past. And in a way that is good a slow growth would mean long and steady growth.
Two million you are CRAZY I will not have even earned one million in my life time. I don't need to go on four cruises a year or drive a vette around town. I am trying to have my house paid off and I will be happy to do volunteer work somewhere. I can't believe how MATERIALISTIC everyone is here living like the rich and famous. When you die it all goes back to dust. You just have to have food, shelter, and clothing. You don't have to spend 50K a year when you are retired. What are you doing with all that money?
When I was 25, a representative from my former company encouraged us all to invest our 401K funds into 100% index stocks. He had charts & graphs showing an average 7 - 8% annual return until we retired. He warned about the risks yada, yada but said stock always rebounded after a short-term dip... He did suggest that as we grew older we should accept less risk but no one warned us that we could lose 40% in one month and that it would take 8 years to recoup the loss...
Funny how today we are scrambling to find something that just protects our 401K from loss! I finally found a fund that provides 4.5% guaranteed this year and is FDIC insured. It is tied to my employer and not available to the masses, but I like the security combined with the modest gain... However, I won't be retiring with $2 Million! Maybe my wife & I combined may reach $750K, but how far will that go with inflation in 20 years?
I find it ironic (and a bit insulting) that Wall Street has the nerve to ask workers and small investors to commit to the stock market for their entire working life when they themselves won’t commit to any investment or market strategy for more than about two weeks.
At 40 I am still heavily invested in the markets through a combination of 401k, IRA and brokerage accounts. Stared investing for retirement when I was 28, two years after I got my Master's Degree in engineering and saved as much as I could every year while constantly looking for better opportunities for higher paying jobs. Always actively managed my portfolios, updating the allocations every 4 to 6 months and kept up on just basic financial news. Currently all investments sit at around $200,000. Could have lost a lot of money in 2008 if, like most people, I wasn't paying attention. But I educated myself about the markets enough to know that when the DOW started bouncing around 11,200 mid year it was time to get out and I did. Preserved most of my assets and was able to reinvest them at much lower values and have ridden the market back up. Maybe some people call that luck. I call it being prepared.
It isn't rocket science. Anyone with a brain can invest in the market. But they have to be willing to put in the time and learn about the markets. Most people don't and they suffer because of it. They think autopilot and randomly picking investments is a sound strategy and they wonder why their portfolios go sideways or down. You don't have to micro-trade to make money. You just have to revisit what you are doing every couple months or twice a year and take the hour or two out of your week to get it done.
Most of my investments over the past decade managed by other people returned about 6% per year. Investments I had direct control over returned 10% per year. Pretty darn good in an era where everyone complains about losing money in the market. Just step back. Spend some time learning. Don't panic at every 300 pt hiccup and you can still make money in the market. But if you are ignorant, uneducated investor who gets spooked easily, well, you're going to suffer.
Now, everyone who hates the markets, hates investors and thinks that the economy is a scam give me a thumbs down. Come on, you know you want to.
First, you don't need $2 million. Sure, you can live to be 100 but look around, how many people in their 80's are going to Churchill Downs for the Derby then jetting off to Milan to see the newest fashions? As you get older your living costs may go up but your discretionary spending is going to go way down. So start saving now, anything is better than nothing and it gets real easy to sleep at night when you have a half million dollar portfolio.
Second, you have to give the stock market a shot. True, some people have been burned but they are also the ones complaining the loudest. Thirty years ago I decided to make a big bet on a tobacco stock. Over a period of 5 years we put in about $50,000 into 401k and college savings directly tied to that company. Because my wife left that company after 5 years that investment has not had any further contributions and it has now grown to over $800,000. I will be the first to admit that it was all luck, it could just as easily been Enron or Worldcom and I could have nothing. But it wasn't and I for one have no complaints about the stock market.
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