How to Double Your Retirement Savings While Just Lifting Your Finger Smart Change: Personal Finance
Looking to turn your hard-earned salary into a nice nest egg later in life? If you’re reading this, you probably are. And if you’re reading this, you’ll also likely know that the stock market is the best way to beat the impact of inflation. Savings accounts, CDs, and even corporate bonds fall short of the job.
The thing is that reaping good profits from stocks does not require a lot of time, effort or maintenance. Arguably, it’s better to be a really passive investor and leave things on their own for years on end. Here’s an easy recipe to multiply your investment by a factor of 10 – and it doesn’t even require you to start with a big chunk of money.
1. Purchasing in the wide market every year
There are several proverbial ways to skin a cat, but the easiest method is also arguably the best. This is buying in a broad market index like Standard & Poor’s 500 with a tool like SPDR S&P 500 ETF Trust (NYSEMKT: spy). This index fund provides you with balanced exposure to the stocks of 500 of the largest companies in the world, allowing you to participate in their long-term growth, which averages 10% annually. Some years are better, some are worse. However, over time, you can expect an average profit of around 10% per year.
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The key is to make Normal Investments, even when you feel uncomfortable, and even if it means you have to cut back on some of your discretionary spending. As you will see shortly, a modest investment made consistently can turn out to be a surprisingly large amount of money later. Likewise, failure to make this contribution year after year can eat into your nest egg eventually.
There is still a lot of trouble? Note that most brokerages can automate the process of regularly transferring money from a checking or savings account to your investment account and also automating the actual annual (or monthly) investment in the fund.
2. Reinvestment of dividends and any capital gains
When you buy a stock or fund, you will usually have the option at the time the trade is placed to reinvest any dividends paid from that position in more of the same stock or the same fund. Choose Yes when given the option, and if your position is already selected, contact your broker – or log into your brokerage account – and switch to this setting.
Sure, it’s tempting to accept dividend payments in cash. You will have access to this spendable money as it arrives, even if your end goal is to use those payments to buy more shares or buy other mutual funds. The important thing is that a lot of investors don’t really stick around to do this, missing out on an important growth opportunity by sitting idly by on their cash or cash-like possessions.
Here’s an example that might motivate you to make that one-time switch: While the average annual return for the S&P 500 has been 11.4% over the past 10 years, that number rises to 13.5% if you reinvest all the profits you’ve collected during that period. This is a big difference over time.
3. Leave him alone for as long as possible
Last but not least (and this is the tricky step), do step #1 for decades, making sure that step #2 applies to any new money and any old money put into retirement savings.
If you set up your brokerage accounts and automated investments correctly, the only thing you need to do to successfully complete step #3 is, well, nothing. Assuming an annual return of 10% for the S&P 500 Index, the usual career extension should put the value of your portfolio somewhere within 10 times your total contributions over that time period.
surprised? do not be. The chart below shows how an annual investment of $5,000 for 36 consecutive years – $180,000 from your own contributions – would be worth about $1.8 million at the end of this time frame.
It’s called a compound. In this case, what multiplies significantly is your past earnings, whether it came from dividends or a capital increase. This means that the bulk of the growth here comes from your earnings, not your annual contributions, so the new earnings from your previous earnings. For perspective, during the last year of this hypothetical 36-year extension, average market gains of 10% would translate to net growth of over $163,000, dwarfing the last year’s new cash contribution of $5,000.
Of course, the sooner you start earning anything, the more growth that can help you in the future.
least is more
The formula is not complicated. In fact, investors who care about keeping things simple often tend to do better; The pursuit of market-beating returns by repeatedly trading individual stocks (ironically) often lagged the market’s performance. Index funds solve this problem well.
It would also not be wrong to set up scheduled deposits, investments, and reinvest in index funds and then not look back for years on end. This approach avoids the risk of trying to time the market – automation helps greatly in this regard.
The hardest part, then, is getting started as soon as possible and staying committed to your automated plan for as many years as possible. Even if you have to make some tough spending choices to make it happen, it’s worth the sacrifice in the long run.
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James Bromley has no position in any of the listed stocks. The Motley Fool does not have a position in any of the stocks mentioned. Motley Fool has a disclosure policy.