Because people don’t understand how IRAs or interest works, they often fail to take advantage of powerful investing techniques available to almost everyone. One of the best vehicles for growing wealth and retiring with financial stability is the IRA, aka the individual retirement account. What if I told you that contributing the yearly maximum of $6,000 would yield approximately $1 million dollars in 30 years? Here’s how that actually works and how it will make you want to get started now.
The IRA: Making Common People Uncommon Millionaires
Some people are lucky enough to have pensions or at least a 401k with employer matching but many of us are stuck with only an IRA as our only retirement savings account. Though IRA accounts have lower yearly contribution maximums compared to a 401k, they still provide tax benefits and can let us retire as millionaires.
IRAs are free to open and most have very low management fees. You can open some with just a dollar and set up automated or manual contributions. You also don’t need a lot of financial knowledge for them, especially if you follow my simple tip to become a millionaire.
There are basically two types of IRAs: Traditional and Roth. Their difference is all about the tax structure. You get a tax break now with Traditional IRAs and pay taxes on any withdrawn funds later. With a Roth, you don’t get a tax break now for your contributions but your withdrawn funds will be tax free once you retire. Both have the same contribution limits and general operation.
Either is fine for our purposes and I encourage you to see which one fits your situation best. Starting in 2019, the yearly contribution limit increased from $5,500 to $6,000 and will likely increase as time passes.
The main thing to know is how to direct your money when it goes into funding the account and to always make the maximum contribution each year. That will make all the difference on your final account balance.
The S&P 500 Beats All
Warren Buffett famously made a $1 million bet that an S&P index fund would beat the performance of a collection of hedge funds over the long-term of 10 years. He won his bet and the money went to charity. Buffett knows that the S&P 500 – a collection of 500 of the top US stocks – is perhaps the most reliable generator of returns over the long-term. During that 10 year bet, the S&P index fund that tracks the S&P 500 earned 7.1% compounded interest annually, compared to the hedge fund average performance of 2.2%.
Is 7.1% interest a good rate of return on your dollar? Yes. One reason is that your money will basically double every 10 years at this rate. For instance, if you contributed $6,000 a year into your IRA and bought only the S&P index fund, after 10 years at its 7.1% average you would have contributed $60,000 but now have $89,204.96 thanks to interest. Do the same thing for 30 years and you will have contributed $180,000 but have approximately $618,036.42 thanks to interest and the power of your money doubling every 10 years.
That 7.1% return for the S&P index fund ran from 2007 to 2017, including the height of the Great Recession. Not bad at all, especially when the algorithm-run hedge funds only averaged a return of 2.2% over that same time. However, the 90 year average for the S&P 500 is actually 9.8%. This is important since a 10% interest rate means your money doubles every 7 years as compared to every 10 years at just 7%.
What does this mean for your money?
If you contributed $6,000 a year for 30 years into the S&P index fund at the S&P’s average return of 9.8%, you will have invested $180,000 but have approximately $1,043,477.93 at the end of those 30 years. In other words, you will be a millionaire. This is the power of interest and why the interest rate matters.
Be a Millionaire
Get rich schemes and fancy stock picking are long-shots akin to getting drafted into the NBA or winning Wimbledon. People like you and me shouldn’t gamble on that for our future. However, we do need to make plans for our retirement and financial futures. The S&P index fund is one of the best, most reliable vehicles for growth open to everyone. If you started maxing out your IRA every year from age 18, you’d be a millionaire around age 48. If you started at 30, you’d reach that goal at 60.
And the longer you contributed and left your money to grow, the richer you’d be.
The 18 year old that contributed money every year until 68 would have roughly $7,137,950.30 at the end of 50 years thanks to compound interest. This is why starting early is so important with money. Time is on our side thanks to the doubling power of 7% and 10% interest rate returns.
Get Started Today
Even if you’re 40 and without a dollar to your name, you can be a millionaire by the time you have to start withdrawing from your IRA at 70. If you’re younger than 40, you’ll reach that hallmark sooner. If you’re older, you’ll still benefit from the average S&P index fund interest rate of between 7.1% and 9.8%.
Will the S&P always return this rate? Who knows but it has a better track record than most anything else out there. All of us would probably be best served by opening an IRA today, investing in an S&P 500 index fund, and maxing out that $6,000 contribution each year. Not only will we reap tax benefits, we’ll be building wealth now and financial stability for the long-term. Our future selves will more than thank us.
Note: Want to see how compound interest works? Check out the compound interest calculator at Moneychimp.
Like this article? Share it so that others learn these financial secrets and start living their best lives now.
Disclaimer: I am not a financial advisor. All of this is in my own opinion.