Dreaming of yacht life? Yachts come in a vast range of price points, from $250,000 to $250 million. The higher end of that range is reserved for the world’s richest and highest-income people. But the lower end of the range, that’s where the average joe can operate.
If you have $500 and a few decades of patience, you can save up $500,000 to buy your yacht and set sail. So water you waiting for?
1. Choose your investment account
The crux of this plan is to invest in the stock market. But before you start buying securities, you need an account to hold them.
Image source: Getty Images.
You can stash your yacht fund in a 401(k), traditional IRA, Roth IRA, or a taxable brokerage account. The table below shows a breakdown of key tax rules and withdrawal restrictions for each.
Account Type
Contributions
Earnings
Distributions
Withdrawal Restrictions
401(k)
Pretax
Tax-deferred
Taxable
The IRS normally charges a 10% penalty on withdrawals before 59 1/2.
Traditional IRA
Pretax
Tax-deferred
Taxable
The IRS normally charges a 10% penalty on withdrawals before 59 1/2.
Roth IRA
After-tax; contributions are subject to income limits
Tax-deferred
Tax-free
You can withdraw your contributions at any time without penalty. Withdrawals of earnings before the age of 59 1/2 will carry a 10% penalty.
Taxable brokerage account
After-tax
Realized gains, interest, and dividends are taxed annually
Tax-free
None
Table data source: IRS.
With a couple caveats, the Roth IRA may be best suited for a yacht fund. The big benefits are tax-deferred earnings and tax-free withdrawals after the age of 59 1/2. You contribute with after-tax money, which spares you from a huge tax bill when it’s time to withdraw a half-million dollars to buy the yacht.
And a-boat those caveats. First, you can’t make Roth IRA contributions if your income is too high. Married filers must make less than $198,000 annually to qualify for the full contribution amount. That full contribution is $6,000 in 2021 or $7,000 if you’re 50 or older. The cap for single filers is $125,000 annually.
Second, you normally can’t withdraw the earnings from a Roth IRA without penalty until you are 59 1/2. That rule applies to any tax-advantaged retirement account. If you plan on setting sail earlier on life, grow your yacht fund in a taxable brokerage account instead.
2. Choose an investment strategy
Your next action item is to choose an investment strategy. If you’re a novice investor, the simplest route is to ride the coattails of the stock market. You do that by investing in a fund that tracks the performance of a broad market index.
Two popular and investable indexes are the S&P 500 and the Russell 3000. Here’s a quick overview of each:
The S&P 500 includes 500 of the largest and most established public companies in the U.S. The index accounts for about 80% of the entire stock market.
The Russell 3000 includes the largest 3,000 public companies, accounting for 98% of the entire stock market. While the S&P 500 is focused on large-caps, the Russell 3000 includes small and mid-sized companies, too.
The Russell 3000 offers more diversity, including exposure to smaller companies which, in theory, can grow faster than larger ones. Even so, the two indices show very similar performance over the last 10 years, as shown in the chart below.
3. Invest in a fund that follows your strategy
You should have no trouble finding a fund or exchange-traded fund (ETF) that tracks your preferred index. If you’re investing in a 401(k), you will probably have access to one S&P 500 mutual fund. In IRAs and brokerage accounts, you may have too many options.
To narrow your choices, compare similar funds by their expense ratios. The expense ratio is the percentage of your investment that pays the fund’s operating costs. A lower expense ratio means a greater portion of the underlying investment returns flow through to you.
You can see this dynamic in the table below. The two Vanguard funds have lower expense ratios compared to their peers tracking the same index. These two funds also show higher returns, even though their portfolios are essentially the same as their peers.
Fund Name
Fund Size
Expense Ratio
Benchmark Index
10-year Average Annual Return
SPDR S&P 500 ETF Trust (NYSEMKT: SPY)
$361 million
0.0945%
S&P 500
14.24%
Vanguard 500 ETF (NYSEMKT: VOO)
$731.5 billion
0.03%
S&P 500
14.35%
iShares Russell 3000 ETF (NYSEMKT: IWV)
$11 billion
0.20%
Russell 3000
14.02%
Vanguard Russell 3000 ETF (NASDAQMUTFUND: VTHRX)
$2.2 billion
0.10%
Russell 3000
14.06%
Table data source: SSGA, Vanguard, iShares.
4. Wait
In investing, time is your best friend. The more time you can let your investments grow, the less you must contribute out of your pocket to reach your savings goal.
The table below shows the monthly contribution amounts needed to reach $500,000 over different time frames. The numbers assume the investment is held in a tax-deferred account and produces a market-average return of 7% after inflation.
Timeline
Monthly Contribution
Ending Balance
30 years
$500
$500,000
25 years
$655
$500,000
20 years
$1,000
$500,000
Table data source: Author calculations.
As you can see, the yacht funding plan that starts with $500 takes 30 years to develop. If you wait 10 years, your required monthly contribution doubles. You also run the risk of needing to jump ship to contribute more than what’s allowed to an IRA.
Yacht so fast
You can turn $500 into a yacht, but it takes time and patience. Investing, done right, is a long-term play. Accept that concept and buoy, you can create a lot of wealth over time — even enough to set sail on the retirement of your dreams.
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Catherine Brock owns shares of Vanguard S&P 500 ETF. The Motley Fool owns shares of and recommends Vanguard S&P 500 ETF. The Motley Fool has a disclosure policy.
