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David Fulton is a Colorado Springs, CO fee-only financial planner providing Hourly and On-Going Financial Planning and Investment Management. While he works with a broad range of clients, David specializes in working with Active and Retired Military, Federal Employees, and Families with Special Needs Children.
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An article popped across my feed tilted Number of Fidelity 401(k) millionaires hits record high. It was compelling and exciting and brief. The premise was that a record number of investors became millionaires this spring simply by leveraging their workplace 401(k) accounts. I quickly shared it on my Facebook page and moved on with my day. But I couldn’t stop thinking about it. What I came to realize is that what the article was really suggesting was not that others are killing it. Rather, that WE can kill it. Our goals are in reach and we just may not realize it yet.
Why Do We Care About a Million Dollars?
A million dollars is just a milestone that is big enough that it seems impossible to obtain given the average median income of $59,000 in the United States. A million dollars is large enough that the majority of people we know will never accrue that much savings. But here’s the thing. It is a number that is exclusive because of our behavior, rather than the number itself. The implausibility of reaching a million dollars is in our head, not in our checking account.
Here is the most important part of the article...
"Individuals are increasing their savings rates, they're taking advantage of their company match and they're keeping a healthy percentage of stocks in their account," says Jeanne Thompson, senior vice president at Fidelity Investments. "It takes many years of consistent saving and investing, but following these steps as part of a long-term retirement strategy can put an individual in a good position to eventually reach this savings milestone."
Did you get that? It’s about the mentality of the investor that is the most important factor. It takes years of consistent saving and investing. WE are the impediment to reaching a million dollars. Humans are irrational. The math required is consistent.
What it takes to save $1,000,000
Not much actually.....if you get started early enough. For those who were able to invest early in their career, compound interest does most of the work. If you were able to diligently sock away money every month for 40 years, you would only need to invest $404.61 per month to reach a million dollars given a 7% return. The IRA contribution limit for an individual is $5500/year or $458.33/month. You could put that entire million dollars in a tax friendly account and never have to pay taxes on the capital gains.
So what about the rest of us who did not have as much foresight and missed out on opportunities when we were young? It’s not too late. If your 35 , you still have 30 working years left until retirement. For 30 years the number unfortunately doubles to $855/month, which still only represents 15% of that $59,000 median income we discussed before. Saving $1,000,000 is certainly attainable, but what does that number really represent?
The 4 Percent Rule
The original 4 Percent Rule was based on a study in the 1990s that determined how much of a portfolio you could withdraw to live off of for at least 30 years of retirement. The rule of thumb states that to determine your retirement number, first determine your annual income required during your retirement years. It is typically 85% of current income, then subtract any pensions (and social security income if you’re an optimistic person).
For example. If you make $75,000/year, you would need approximately $60,000/year in retirement because you would not need to save for retirement anymore, the kids are out of college, and you may have even paid off your house. If you earn a small pension or social security income of $20,000/year that would leave you with a remaining requirement of $40,000/year you would need to supplement with your investment income.
To apply the 4 Percent Rule, simply divide $40,000 by .04. The result is how much savings you need to accumulate for a 95% chance of living off of your retirement savings for 30 years. In this example you would need to save $1,000,000! Said another way, a million dollars represents a 95% chance of an annual income of $40,000 during a 30 year retirement.
Keep in mind the 4 Percent Rule provides just a general guideline. You should really use more precise methods to decide how much money to withdraw each year in retirement once you get close to those golden years. As an upcoming retiree, your plan should account for other sources of income, types of investments used, expected longevity, expected tax rate each year, and numerous other factors. As you build a smart retirement income plan, it often may lead to more withdrawals in some years, and less in others.
What should YOUR goal be?
A million dollars is a nice round number, but doesn’t really mean anything other than a hypothetical withdrawal rate. Your savings goals should be tied to very personal factors in your life and there are no easy rules of thumb in determining what this number is. It takes hard work, and is difficult to predict a specific number accurately. There are many variables that change over time..
This is why financial planning is so important. It’s not about the plan in isolation, but rather the process. Your plan should be monitored and updated routinely to account for changes in government benefits, availability of services, your families health and well-being, the uneven impact of inflation, expected returns of your investments, and future tax rates.
It’s not too late to start saving. Your goals are in reach if only you determine them early enough. The sooner you maximize your savings, the greater effect compound interest will have in helping you achieve your savings goals. Every day counts.