We talk about saving for “retirement”, but what we really want is to create financial independence where you can work if you want to, but not because you have to. We create that wealth by saving.
When the market does well, people want to save and invest. It feels good when it is working! When there is volatility like in December 2018 (the worst December since 1931 according to Barrons), people don’t want to invest and saving becomes a lower priority. If they do save, it is either just going into checking or paying down debt. Both of those are part of a good financial plan, but that’s not the path to becoming a millionaire.
I think most Americans have a hard time imagining that they could become a millionaire, but one million dollars is not a vast amount of wealth in 2019. At a standard 4% withdrawal rate, a $1 million nest egg only provides $3,333 a month in distributions. And that is pre-tax! Take out 20% for taxes and you’re left with $2,666 a month net.Â
With inflation of just 2-3%, one million dollars will have less than half the purchasing power when today’s 30-somethings reach retirement age. If you think you need $1 million in today’s dollars, you might need $2 million or more when you are 65 to maintain the same lifestyle.
I’m glad that the market has rebounded nicely in the first quarter of 2019. Looking ahead, there remains a great deal of uncertainty: rising inflation, falling corporate profits, an inverted yield curve, and so on. It’s easy to feel uneasy today. No one knows what will happen in 2019. In spite of Q1, it looks like a rough road ahead.
But it doesn’t matter. At least not to a long-term investor. And most of us are long-term investors. I don’t just mean people in their twenties – even if you are in your sixties and retiring soon, you’re not going to be pulling all your money out in the next two years. You still have an investment horizon of 20, 30, or more years.
We can’t let market volatility – or the fear of any one year – impact our commitment to saving and investing. Don’t try to time the market with your savings strategy. I have no idea what will happen in 2019 or even for the next five years, but I’m going to keep on saving and adding to my diversified portfolio. (I follow our Growth Model.)
I have been thinking recently about 10 years ago, March 2009. It was a terrible time in the market. The S&P 500 had been cut in half. It felt like every day was a new disaster. 2% drops were the norm, and there were the really bad days when the market would fall by 5% or more. As a financial advisor, I talked with people who were afraid, upset, and angry. My own account was down $200,000 at one point. I remember thinking that I could have paid off my mortgage if I had sold (at the top), and I’d still have more money left over than I had right then. Lots of would-a, could-a, should-a regrets.
I told people to stay the course, and that’s what I did. Thankfully, most followed my advice. Looking back with the gift of hindsight, it was an incredible buying opportunity and would have been a terrible mistake to sell. But it didn’t feel so obvious at the time! I didn’t get any calls from people who wanted to buy in February or March 2009.
Fast forward to 2019: if you had purchased the S&P 500 Index ETF (ticker IVV), your ten year annualized return to February 1, 2019 would have been 14.95% (source: Morningstar). Incredible!
Now, that is cherry-picking the bottom of the market. So to be fair, let’s take a longer look. If you had invested 15 years ago, even with riding it all the way down in 2009, your 15-year annualized return of IVV still would have been 8.13%. Even with the biggest financial disaster since the Great Depression, investors in a basic stock index fund still have earned an 8% annual return over 15 years. That’s the sort of time horizon we should be thinking about.
At a hypothetical 8% return, you would double your money every nine years, with no additional contributions. If you had invested $100,000 into a fund and received 8.13% for 15 years, you’d end with $322,993. This is why we should keep saving and investing, despite whatever fear we may have about the market, politics, global risk, or whatever we may face in 2019 or in any single year.
How much should you save? IRA contribution limits have been increased in 2019 to $6,000 (or $7,000 if age 50 or older). That’s $500 a month, which is a lot for many Americans, but very doable and certainly a good place to start.
If you can earn 8% on your $500 a month, you will have $745,000 after 30 years. You will break $1 million in less than 34 years. For a couple, you can both invest in an IRA, so you could double these amounts. Most studies of retirement planning assume 30 years of accumulation. The question facing each of us is when to start. If you can start saving at 22, you could (potentially) have a million in your IRA by your mid-fifties. If you don’t start saving until age 40, it would take until your mid-seventies to reach the same level.
Some of you reading this have household incomes over $200,000. Can you save $5,000 a month? It’s possible, especially if you both have 410(k)’s with matching contributions. If you save $5,000 a month for 30 years, at 8%, you’d have $7,451,000. With that size nest egg, and a 4% withdrawal rate, you’d have nearly $300,000 in annual income. That’s actually more than your previous income.
Save early, save often, save as much as you can. No one has a crystal ball about what the market is going to do, but thankfully, accumulation has not been dependent on market timing. What has been successful in the past has been having a well-diversified asset allocation, using index strategies, and keeping expenses and taxes low.
Maybe instead of focusing on what the S&P 500 did in 2018 or your portfolio return over 12-months, we ought to track our savings rate. How much did you save in 2018? Are you increasing your savings in 2019? Are you saving enough to meet your goals? At your current savings rate, how long might it take to become financially independent?
If you are concerned about low rates of return in the years ahead, we may need to save more. But there’s no intelligent process for becoming financially independent, becoming a millionaire, that doesn’t include regular savings. We are always happy to talk about our investment strategy and why we invest how we do, but the conversation that more of us should be having is how to save more.
Past performance is no promise of future results. Historical returns are not guaranteed.
