Sophia Bera is an associate planner for a fee-only financial planning firm in Minnesota. She just passed the exam to become a Certified Financial Planner and will get her CFP designation in August.
Here's the math
Many people think: “I’ll never be a millionaire!” But with the power of compound interest, and time, you too can have a million bucks. Here’s how:
Let’s say you’re in your twenties and you have about 45 years until you want to retire. (If you're older, keep reading—the basic math still applies.)
If you invested $50 a week, in one year you would have put away $2,600 ($50 X 52 weeks = $2,600).
But in 45 years, those cash deposits alone would only add up to $117,000 ($2,600 X 45 = $117,000). How does that turn into a million?
Just add water
Every day that your money is invested, it gains interest, then your interest earns interest—and your savings begin to snowball.
Assuming your money earns about 8% per year, on average—a reasonable assumption—here's how your savings would grow:
- In 10 years you’d have $40,000
- In 20 years you’d have $128,000
- In 30 years you’d have about $325,000
- In 40 years you’d have over $764,000
- By year 45, you'd have $1,001,605
You take it all
The best part: When you contribute money to a Roth IRA, you've already paid tax on it—and you don't have to pay tax when you withdraw the money. That means you can withdraw $1,000,000 entirely tax-free!
So how can you start? Open a Roth IRA at a discount brokerage firm such as Fidelity, Vanguard or T. Rowe Price. Just call them. They're nice. (They want your money!) You can set up automatic contributions from your bank account to your Roth IRA easily, usually by filling out and faxing or mailing a form.
You don't need a lot to start. Fidelity will waive its $2,500 account minimum if you set up an automatic deposit of at least $200 per month. If that’s too much, T. Rowe Price will allow you to set up a Roth IRA with monthly contributions of only $50 per month. (Vanguard requires a $3,000 initial deposit.)
Then, once your Roth is open, you have to choose your mutual funds. I recommend very low-cost funds called exchange-traded funds (ETFs) and index funds, which many of you have read about here.
If you’re a new investor, I recommend that you start with a fund that tracks the U.S. stock market. That means you get the overall market return, which tends to rise steadily over time. You can go with an exchange-traded fund like iShares S&P 500 index (IVV is the ticker symbol), or Vanguard's Total Stock Market Index fund (VTSMX).
The advantage of ETFs is that they operate like index funds, i.e. they track a certain segment of the market, but they trade like stocks. What does that mean? Any time you want to sell your shares and get into something else, it's a snap. There's no penalty, only the commission fee you'd pay on any trade.
If you have $10,000 or more saved already, I recommend that you diversify your investments. A balanced portfolio might look like this: 25% in iShares S&P 500 Value (IVE), 25% in iShares S&P 500 Growth (IVW), 25% in iShares MSCI EAFE (EFA)—this is an international index ETF, and 25% iShares iBoxx Investment Grade Corporate Bond (LQD). This is what is known as a 75/25 portfolio. That means the portfolio is invested in 75% stocks and 25% bonds.
All of the funds I listed have an expense ratio of less than 0.40%. This is roughly half of what you’d pay to invest in a managed mutual fund. The lower the expense ratio, the more of your money you get to keep. So choose a few low cost index funds to invest in, and you’re on your way to becoming a millionaire!
|Sophia Bera is an Associate Planner for a Fee-Only financial planning firm in Minnesota. She recently passed her Certified Financial Planning exam and will have her CFP® designation in August 2010. In her free time, she does math for fun, performs at various theatre companies around the Twin Cities and travels to exotic places with the love of her life, Jake.|