It may seem like accumulating enough for retirement requires large sums of money. And if you're saving for this milestone with just your contributions, this may be the case.
But if you invest your money and benefit from stock market returns, you can potentially grow your account to $1 million by making and investing an annual contribution to an IRA. Here's how.
What's an IRA?
An IRA is an investment account that can help you save money for your retirement. You can invest the money that you put into an IRA and it grows tax-deferred. If you meet certain requirements you can add to this account and your contributions may also qualify for a deduction from your taxable income.
The amount you can contribute has grown from $1,500 since 1975, when this investment account was first created, to $6,000 in 2019. It's possible that you'll see this number continue increasing in the future and if that's the case, these projections will change. But using the current contribution limit, this is how much your account could grow over the next 30 years.
How your accounts could grow
The table below shows what would happen if you invested $6,000 each year for 30 years at various rates of return. As you can see, the return your investments generate eventually dwarf the $180,000 in contributions you make.
Rate of Return
What it takes to earn these rates
The rate of return you earn each year in your IRA depends on how you invest your money. While a more conservative approach (i.e., one that leans heavily toward bonds) can protect your gains, it may also limit your potential upside. And it's wise to revise your asset mix over time as your time horizon shrinks.
Between 1926 and 2020, you could've earned 6% if you owned a portfolio that consisted of 100% bonds, 7% with a mix of 20% stocks and 80% bonds, 8% with 40% stocks and 60%, 9% with 60% stocks and 40% bonds, and 10% with 100% stocks.
The riskier your portfolio is the more you can potentially gain over the long term. But you can also lose more during bear markets.
For example, even though large-cap stocks have earned on average 4% more each year than bonds over this time period, their worst year resulted in a 43.1% loss. The worst year for bonds during that same time was a loss of 8.1%. Withstanding a year of negative losses like that at the beginning or middle of your career might not have a huge impact. But as you near retirement, that type of loss could be devastating.
That's why rather than having one asset allocation during your entire life, you'll probably have a combination of them. And as your time horizon gets shorter, you may want your investments to move in a more conservative direction. As you make these changes, projections of how much your money could grow will change, too. And if you're working toward a certain goal, reviewing these adjustments annually could help keep your goals in line with the time frame you hope you will achieve them in.
With enough time before you retire, you could grow your accounts by a lot without needing large sums of money. But contributions alone probably won't be enough. And how you invest your money combined with the consistency with which you make these contributions could determine just how much money you end up with.
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