Setting up a regular investment plan to reach $1 million in 40 years is an achievable goal. You need some help along the way with some positive investment returns, and if the markets help, you may end up with much more than $1 million. Use proven investment strategies and techniques to give yourself the best chance of reaching your million-dollar goal.
Effects of Rate of Return
If you stored your cash in a safe, earning zero percent per year, you would need to lock away $25,000 every year to have $1 million in 40 years. If you were able to invest like Warren Buffet and earn 19.8 percent per year, you would need to save just $150 per year. Of course, Buffet can buy whole companies, which helps with his long-term returns. Using some more realistic return numbers, at the 9.2 percent average return for the S&P 500 from 1965 through 2011, you would need to invest $2,805 each year. At the 5.4 percent return for bonds quoted by the AARP, the required yearly investment amount would be $7,500. The average investment return makes a tremendous difference on your final results.
Returns are Not Linear
In your planning to reach $1 million, it is important to remember that the returns from the stock and bond markets vary considerably from year to year and decade to decade. From 1991 to 2011, the annual returns from the stock market ranged from a loss of 37 percent to a gain of almost 38 percent. Four years out of 20 were down years for the stock market. Your long-term investment plan must allow for the down years in the market. Also, in the early years of your savings plan, most of the growth will come from your annual deposits. In the later years, the investment gains should carry the load.
Invest Early and Asset Allocation
The amounts you invest in the early years have the longest time to generate compound growth, so invest as much as you can when starting your plan. If you think $3,000 a year at 9 percent will work, start with $5,000 per year and reduce you investment amount in later years when you have hit the projected annual returns. An investment portfolio balanced between stocks and bonds allows you to reallocate when the two sides get out of balance. You will then buy more stocks when the market is down improving your returns. Your allocation should be mostly in stocks in the early years and shift to a higher percentage of bonds as you get close to year 40.
Think About Taxes
Income taxes can have a serious detrimental effect on your investment gains. Paying taxes at a 33 percent rate reduces your investment return from 9 percent per year down to 6 percent. Avoid paying taxes on your gains by using tax-deferred retirement accounts. Saving through your 401(k) plan at work or setting up your own IRA keeps taxes from slowing down your growth toward that $1 million. Stock and bond mutual funds would be appropriate investment choices in either type of retirement plan.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.