Most Americans are not on pace to meet their retirement savings goals. There are a number of reasons for this, and not every household is dealing with the same circumstances. Still, it's important to understand the recipe for maximizing long-term performance. This way, you can assess your strengths and weaknesses, then measure your progress toward retiring a millionaire.
It's important to maintain the right asset allocation in your retirement portfolio. The allocation should reflect your goals, time horizon, and risk tolerance. To achieve this balance over time, most accounts should be invested across several asset classes, including growth stocks, value stocks, dividend stocks, bonds, and cash.
If you're looking to turn $100,000 into $1 million, assume that your priority is growth and that you have the appropriate time horizon and risk tolerance to prioritize growth responsibly. Investors who are at least 15 years away from retiring have the luxury of ignoring short-term volatility in favor of maximizing upside potential.
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Retirement portfolios allocated for aggressive growth tend to have higher exposure to growth stocks, small- and mid-cap equities, and emerging markets. Young investors often have little to no bond exposure in their retirement funds, and value stocks are also less prevalent.
Most 401(k) plans allow participants to select an allocation plan, providing an aggressive growth option composed of exchange-traded funds (ETFs) and mutual funds. If you are managing a traditional or Roth IRA, you can build your own portfolio of ETFs, mutual funds, and individual securities. Popular growth ETFs, such as the Vanguard Growth ETF, Invesco QQQ Trust, and the iShares Russell 1000 Growth ETF have averaged 12% to 15% compounding annualized returns during the past five years.
The past five years might not be indicative of long-term performance, but these growth-focused vehicles still provide an opportunity to outperform major market indexes if you ignore volatility. At that rate, it would take somewhere around 20 to 25 years for $100,000 to grow into $1 million.
Dividend stocks have a role in just about any retirement fund, but they are often overlooked as a growth investment. They tend to be mature companies that don't expand as quickly as disruptive tech stocks. However, they can be reliable cash-flow generators that pay dividends, which can be reinvested for compounding growth.
It's common for dividend stocks to yield 2% to 3% annually, which is a great way to deliver gains even during periods where the market is down. It's important to take those gains and purchase more shares to unlock compounding returns. A hypothetical $100,000 portfolio that delivers a 3% yield that doesn't grow over time would generate $60,000 in dividends over a 20-year span. If those dividends were reinvested each year, the compounding effect would push net returns to more than $80,000. This effect grows if the portfolio expands over time, so it's especially important for shareholders of Dividend Kings, or those companies that have increased shareholder payouts for 50 consecutive years or more.
Market timing is a tempting strategy, but it's almost never the best way to maximize long-term performance. There are too many variables that influence bull markets and bear markets, and unexpected factors often trigger huge swings higher or lower. Humans also tend to react emotionally to news that's already been reflected in equity prices, so active trading strategies often lead to buying when prices are already high and selling when they're beaten down.
Even if you have a good handle on the forces dictating major trends, it's still hard to know exactly when a major shift is about to come. If your prediction on a recession and market correction is a quarter too late or too early, the negative impact on your retirement account performance can be substantial. The stats overwhelmingly show that active strategies rarely match the returns of lower-risk passive index fund strategies.
The best long-term investment plan is to develop a strategy that's designed to function across market cycles. That way, you won't have to panic when a bear market hits or take irresponsible risk during a bull market. Plan to adjust your allocation over time, based on your retirement time horizon. It's OK to make modest adjustments if market conditions hit extreme conditions, like we've seen in previous asset bubbles, but even those should be minimized.
Saving the right proportion of earned income is the first step in asset accumulation. Building your retirement account to $100,000 is a phenomenal start, but there's still work to do. If there's enough time to grow those accounts by 10-fold before you retire, then you almost certainly have time to retain and invest a portion of your earned income.
The key with saving is to approach it in a measured and systematic way. You should have a target savings rate, and take quantifiable steps to reach that goal. Most households should strive to save 15% of their annual income to meet retirement goals. The more income you can keep for yourself, the more you can invest.
If your employer offers a 401(k) match, then it's usually a good idea to take advantage of that. It can also be helpful to dedicate a specific amount of each paycheck to a separate account, whether that's a savings account, a brokerage account, or an IRA. Some people even use direct deposit to fund multiple bank accounts with each paycheck, enforcing discipline on spending.
A $100,000 retirement account growing 8% annually will take 30 years to hit $1 million. That same account will reach $1 million in just over 20 years if an additional $10,000 is saved and invested each year.
Ryan Downie has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Vanguard Index Funds-Vanguard Growth ETF. The Motley Fool has a disclosure policy.