How to 10x Your Retirement Savings While Barely Lifting a Finger
Looking to turn your hard-earned wages into a nice nest egg for later in life? If you’re reading this, chances are you are. And if you’re reading this, you probably also know that the stock market is the best way to overcome the effects of inflation. Savings accounts, CDs, and even corporate bonds just aren’t up to the task.
The thing is, reaping nice gains from stocks doesn’t take a lot of time, effort, or maintenance. You’re arguably better served if you’re a truly passive investor and just leave things alone for years. Here’s a simple recipe for multiplying your investments by a factor of 10 — and it doesn’t even require starting with a big chunk of cash.
1. Shop the broad market every year
There are several ways to skin a proverbial cat, but the easiest way is also arguably the best way. That means buying into a broad market index like this S&P500 with an instrument like that SPDR S&P 500 ETF Trust (SPY -1.15%). This index fund gives you balanced exposure to 500 of the stocks of the world’s largest companies, allowing you to effectively participate in their long-term growth averaging 10% per year. Some years are better, others worse. However, over time, you can expect an average gain of around 10% per year.
The key is in doing regular Investing, even if it feels uncomfortable and requires you to cut some of your discretionary spending. As you will soon see, a seemingly modest investment made regularly can later turn into a surprisingly large sum of money. Likewise, failing to make that contribution year after year can dramatically eat into your eventual nest egg.
Still too much hassle? Note that most brokerage firms can automate the process of regularly transferring money from a checking or savings account to your investment account, as well as the actual annual (or monthly) investment in a fund.
2. Reinvest dividends and any capital gains
Typically, when you buy a stock or fund, at the time you place the trade, you have an option to reinvest any dividends that are paid from that position back into more of the same stock or fund. Select Yes if given a choice, and if your position is already set up, contact your broker – or log into your broker account – and switch to that setting.
Sure, it’s tempting to simply accept dividend payments in cash. You have access to that money to spend as soon as it comes in, even if your ultimate goal is to use those payments to buy more stocks or other mutual funds. The thing is, too many investors never really get there and miss out on a key growth opportunity by sitting idly on their cash or cash-like holdings.
Here’s an example that might motivate you to make this once-in-a-lifetime switch: While the S&P 500’s average annual return over the past 10 years has been an impressive 11.4%, that number jumps to 13.5% if you’d reinvested all the dividends you’ve collected over this period. That’s a big difference over time.
3. Leave it alone for as long as possible
Last but not least (and this is the tricky point), do step #1 for decades and make sure step #2 applies to both new and old money going into retirement savings.
If you have your brokerage accounts and automated investments set up correctly, all you have to do is do nothing to successfully complete step #3. Assuming a 10% annual return for the S&P 500, over a typical career span your portfolio should be worth somewhere on the order of 10 times your total contributions over that period.
Surprised? Do not be. The chart below shows how a $5,000 annual investment made for 36 consecutive years – $180,000 of your own contributions – will be worth about $1.8 million at the end of that period.
It’s called compounding. In this case, your past earnings will notably be compounded, whether they come from dividends or capital gains. That means most of the growth here comes from your income, not your annual contributions, which are the new gains from previous gains. For perspective, over the final year of this hypothetical 36-year stretch, the 10% average market gain would result in net growth of over $163,000, dwarfing last year’s new cash contribution of $5,000.
Of course, the sooner you start earning something, the more growth can help you in the future.
Less is more
The formula is not complicated. In fact, investors who value keeping things simple often get better results; The pursuit of market-beating returns by trading individual stocks frequently (ironically) often results in underperforming the market. Index funds solve this problem pretty well.
Nor would it be wrong to set up your scheduled deposits, investments, and reinvestments in index funds and then not look back for years. This approach avoids the risk of timing the market – automation helps tremendously in this regard.
So the hardest part is getting started as early as possible and sticking to your automated plan for as many years as possible. Even if you have to make some difficult spending decisions to achieve this, it’s worth the sacrifice in the long run.