Thursday, June 12, 2008

Getting To A Million Bucks

Most people don't get rich because they refuse to start small. Why bother? Just win the lottery. I can't believe people buy lottery tickets but they do. And the ones I see doing so don't look very smart. And they aren't.

The way to get there is simple, well, kind of. Save two times your annual salary and let the power of compound interest take over. Einstein said that compound interest was the eighth wonder of the world and most people think Einstein was, well, an Einstein.

Jonathan Clements gives the details in the following---

How to Save $1 Million for Retirement

The Wall Street Journal Online
By Jonathan Clements

If you're a newly minted college graduate, the $1 million-plus needed for retirement might seem impossibly large.

Feeling discouraged? Try lowering your sights, aiming instead to accumulate savings equal to two times your annual income.

Once you hit that milestone, the financial wind will be at your back -- and reaching your retirement-savings goal should be a breeze.

Breaking through. Suppose you expect eventually to earn $80,000 a year. Looking ahead to retirement, you reckon that -- in addition to Social Security -- you will want maybe $45,000 a year from your portfolio, adjusted for inflation.

To generate that $45,000, you will need a $1 million nest egg, calculated in today's dollars. This assumes that, in retirement, you use a 4.5% annual portfolio-withdrawal rate.

Investment Growth

"People wonder how they will ever accumulate enough money," says Charles Farrell, a financial adviser with Denver's Northstar Investment Advisors. "But what many investors fail to understand is that, once they reach a certain level of assets, most of the savings should come from investment growth."

Mr. Farrell figures the breakthrough occurs at around two times income. Let's say your salary has hit that $80,000, you have amassed $160,000 in savings, you are socking away 12% of your pretax income each month and your investments earn 6% a year.

Over the next 12 months, your $160,000 portfolio would balloon to $179,518, or $19,518 more. Your monthly savings would account for $9,600 of that growth. But the other $9,918 would come from investment gains. In other words, you've got to the crossover point, where the biggest driver of your portfolio's growth is now investment earnings, not the actual dollars you're socking away.

You should, however, keep salting away money. That sacrifice will be handsomely rewarded, as things really start to snowball. Using the assumptions above, your portfolio would soar from $160,000 to more than $418,000 a decade later. True, part of this gain would be lost to inflation. But inflation should also drive up your salary, allowing you to squirrel away more money.

Get Started Now

Getting started. That still leaves the initial task of accumulating two times income.

"It can take people 12 to 15 years," Mr. Farrell says. "The earlier you can start, the better. But if you're close to two times pay by your early 40s, you're probably in pretty good shape."

As you strive to amass that sum, your top priority should be funding your employer's 401(k) plan. In addition to the initial tax deduction and continuing tax deferral, you will likely receive a matching employer contribution, which will help speed your portfolio's progress.

If you can, save outside your employer's plan, by funding a Roth individual retirement account. That won't get you an initial tax deduction, but you will enjoy tax-free growth. A Roth also offers a heap of flexibility. At any time, you can withdraw your contributions -- but not the account's investment earnings -- without any sort of tax hit. That means your Roth could double as an emergency reserve or as your house down-payment fund.

Investment Ideas

Which investments should you buy? Check out broadly diversified no-load funds like AARP Aggressive and Schwab Target 2040, both of which require a $100 initial investment. Until you reach Schwab's $1,000 brokerage-account minimum, you will need to add $100 every month through an automatic investment plan, where money is pulled out of your bank account and invested directly in the fund.

Also consider Fidelity Freedom 2050 and T. Rowe Price Retirement 2050. The regular minimum at both funds is $2,500. T. Rowe Price will trim that minimum to $1,000 if you open an IRA and waive the minimum entirely if you sign up for a $50-a-month automatic-investment plan. Similarly, at Fidelity Freedom 2050, you can sidestep the minimum if you agree to invest $200 a month through Fidelity's SimpleStart IRA program.