I suppose we should probably get something straight: it’s going to be really hard to save your way to a million dollars. Like, super duper ridiculously hard. Now, I’m not talking about setting money aside every month and putting it into some mutual funds. I’m not talking about saving in a savings account. Have you seen the rates today? Yeah, not exactly the best I’ve seen in my brief lifetime. The point here is that if interest rates stayed averaged 2.50% (closer to the historical average rates on savings accounts) and you put in $100 a month, it would take you about 124 years to save a million dollars. And by that time the million dollars would not be worth much. Although your great grand children will probably enjoy the pool it bought, I think what we’re looking at is a million dollars that we can enjoy.
What I’m trying to get at is that it is a bit unrealistic to save your way to a million dollars. But this doesn’t mean we shouldn’t save! My absolute favorite personal finance book The Richest Man in Babylon gives us the directive to save 10% of what we earn. If we save 10% of what we earn and put that money to good use through investments, real estate and other ventures, we can grow our savings with compound interest. Additionally, because of compound interest, it’s probably a good idea to save when you are in your twenties. Not that you’re out of luck after that point! It’s just going to be very hard.
Simply saving your way to a million dollars will be a slow and tedious task. So what we need is a plan to go along with our thoughts of savings and wealth. I haven’t spoken too much regarding investing on my site until now but I figure this is a decent topic to bring it out in. I once had an economics professor that gave fairly simple advice in how to diversify your money to protect and save from the swings of the market. His method is something I follow today specifically because of its simplicity. Really, it’s a system that you just have to follow and re-balance every year. However, I believe it needs to come with this caveat: if you are someone who will look at your portfolio day after day and worry consistently about then save your money in an ING or Ally savings account or put it under your mattress. You’ll need at least some tolerance for the market if you want to allocate your money this way. Okay, here’s the method!
1. Allocate the money you save and invest into two areas: stocks and bonds. We’ll get into more info on the breakdown of these two groups but for right now, let’s start with the basics. We’ll say you use the Vanguard S&P Indexed Fund and the Vanguard Massachusetts Tax Free Fund because you love the low fees, the consistency of the returns, and the customer service.
2. Now that you’ve chosen your funds, it’s time to actually set the percentage you’ll use. Take your age and voila! That is the percentage you put in the bond fund (VMATX in this case). Every year, on January 1, you re-allocate your funds.
Simple right? As you get older, more and more money is placed in the the bond fund or funds, which won’t fluctuate as much. In my opinion that is a huge benefit. But wait, I said you have to re-allocate at the end of every year! I don’t want to leave you hanging. I should explain this a bit more in depth.
If you really want to save the most money, then re-allocation is extremely important. Most people will say that you should sell shares in one to put them in the other. I’m not most people. I borrowed an idea from Ramit Sethi, the famous blogger from I will teach you to be rich (who wrote a book by the same name) which basically goes like this: when your allocation gets out of sorts because one area is getting too big, then stop buying into that area. This makes so much more sense than by selling and incurring costs. What this does is protect you from buying when segments are high and selling when you shouldn’t. It automatically re-adjusts into the low performing area so you can buy low and sell high later on down the road. Simply and brilliant.
Like I said above, it’s going to take a lot of work to save your way to a million dollars. You’ll need to save 10% of your income (or more! Definitely shoot for more) and find the right allocation of investments and risk for you. Then just watch as the automatic ACH’s more your money every month and your nest egg grows and grows. Until next time!