- Investing for the long term isn’t hard and if you avoid doing stupid things, you should expect to be a millionaire when you retire or likely even sooner.
- Maximize your IRA as it isn’t taxed.
- Beating the market by a few percentage points leads to staggering differences in 30 years.
People usually wonder how much money they should put aside and invest in stocks. Should it be 5%, 10% or 15% of your income? Should you put any lump sums into the stock market or not?
As most of us don’t have clear plans and goals, what happens is that investors invest more when they should invest less and nothing at all when they should go all-in.
Today’s article will describe the expected end result from investing in stocks, how much your investments will return on average, and how to create a stable strategy in order to not make costly mistakes.
How Much To Invest: Maximize Your IRA
I’m going to use the median U.S. household income of $56,516 as a reference for this article. If you have more or less, just divide the end results proportionally and you’ll get your end result.
If you invest 10% of $56,516 in stocks, that would be $5,615. It isn’t a coincidence that the “Individual Retirement Arrangement” (IRA) limit is $5,500, which in many cases can also be deducted from your taxes, making it profitable from the start. Not only that, but transactions in your IRA account aren’t taxable.
For more information about taxation, please consult the IRS and a tax advisor.
To make things even easier, let’s use $5,500 and a period of 30 years as not everybody starts investing in their twenties.
What Returns Should You Expect?
Returns are going to be correlated to the underlying earnings of your investments, inflation, and economic growth. As the price to earnings ratio for the S&P 500 is 26.1, current market expected returns are 3.83%. When a recession comes along, this return will increase for the long term as stock prices fall. With expected economic growth of 2% in the U.S. and 4% globally, earnings will be pushed higher, so this is really the minimum return you should expect in your investment lifetime. Let’s make some calculations.
$5,500 invested yearly for 30 years with an average yearly return of 3.83% compounded annually would give us $311,336.2. In total, you would have invested $165,000.
Figure 1: Portfolio growth with yearly investments of $5,500 and a return of 3.83%.
However, I firmly believe that a 3.83% yearly return from stocks is the absolute minimum you can expect for a few reasons. First, we have to add a minimal inflation rate of 2% and include economic growth of at least 2% as well as corporations increase revenues and earnings alongside inflation and economic growth. Secondly, current market expected returns are close to historical lows. As you invest year after year through boom and bust cycles, your returns can only be higher and will be close to the geometric average returns of 9.5% in the period from 1928—also a peak moment for the market—until 2015. This totally changes your end portfolio amount.
Figure 2: Portfolio growth with yearly investments of $5,500 and a return of 9.5%.
The difference is a whopping $590,156.81.
But, there’s more. Investing through advisors, funds, and ETFs will eat a big chunk of your money in fees. Plus, you would be investing like everybody else does, buying overvalued stocks in market highs and shunning undervalued stocks. That is how market funds operate, they buy more of what’s in demand and less of what is temporarily out of fashion. You can read more about this extremely important but overlooked issue in our articles available here.
Further, you know yourself best. What are the risks you’re comfortable taking? What are your investment goals? These questions probably aren’t quarter by quarter oriented, but rather decade by decade.
So, something that you can do is learn about investing and invest for yourself. By seizing the opportunities the market offers—like the extremely cheap zinc miners we recommended in 2016—and not taking too much risk—we recommended selling REITs in August—you can increase your returns and beat the market in the long term. This requires a little bit of knowledge, but you can get enough of that by continuing to read Investiv Daily.
Let’s say that by investing yourself you only increase your returns by 2% per year, bringing your total return to 11.5% per year. The difference is again staggering. With returns of 11.5% a year, your portfolio would be worth $1.34 MILLION in 30 years, and the difference is $442,146.62 for that small 2% higher return.
Figure 3: Portfolio growth with yearly investments of $5,500 and a return of 11.5%.
How Do I Reach Such Returns?
It’s pretty simple, the main rule is to not do stupid things like investing in bubbles or doing something just because everybody else is doing it. This requires some knowledge and discipline, but as the differences come close to half a million, I think it’s worth it to put some effort into learning about investing.
An average person goes to school for 20 years to work for an average household income of $56,515 per year before taxes. The amount earned in 30 years of working on average is $1.69 million. Remember that for that $56,515 you work 40 hours a week for 50 weeks per year. If you can add half a million to your 30-year income just by investing smartly in stocks, I think it’s worth the extra effort. Plus, it is fun.