BOSTON -- Let's face it: The chances that you'll win a million dollars by appearing on a television game show are extremely small. Your chances of making a million dollars in mutual funds, however, may be much better than you ever imagined.
What's more, you may well need a million dollars to afford a secure and comfortable retirement. Take a couple, both age 35, who need an income of $50,000 a year. To generate the same spending power at retirement age, they'll need an annual income of $124,000, assuming an annual inflation rate of 3 percent over the next 30 years.
They might draw some of that money from Social Security or corporate pensions. But they'll need to rely on personal savings for a large slug of their annual income if they hope to truly retire at age 65, and they'll need plenty of principal to create an adequate flow of income.
Example: Let's say our couple (call them the Riches) can rely on outside sources -- Social Security, pensions, part-time work leaves $62,000 that must come from savings.
How much money does it take to generate $62,000 in annual income? The answer depends upon several variables, including the rate of inflation during their retirement; how much their investments earn each year after they retire, and how long their retirement lasts.
Start with the first two factors: inflation and investment returns. Each year, the couple must withdraw some money from their savings to meet living expenses. Over the long run, they won't be able to maintain a withdrawal rate that exceeds the real return on their investments (that is, the return after inflation).
High investment returns and a low rate of inflation offers the highest real rate of return and allows for the highest withdrawal rate. For example, a couple who earn an 8 percent return on their investments can afford to withdraw roughly 5 percent annually if the inflation rate is 3 percent. But a low rate of investment returns or a high rate of inflation can be big trouble. Thus, a couple who earn only 5 percent on their investments in a world of 5 percent inflation will find that any withdrawal rate will shrink the purchasing power of their nest egg.
A financial planner can help you estimate the nest egg you need to keep up with inflation and meet your spending needs during retirement. Alternatively, you can check out Web sites such as http://moneycentral.msn.com and http://www.quicken.com, which offer retirement calculators and guidance about inflation and rate of return assumptions.
Don't be shocked if you find that you need to come up with a million dollars or more. Accumulating that money isn't nearly as hard as you might think -- providing you take full advantage of time and retirement savings plans such as 401(k)s or SEP IRAs. For example, a monthly investment of $284 in a 401(k) plan will grow to $1 million in 30 years, assuming an 8 percent annual rate of return. Boost that investment to $350, and it will grow to $1,230,000.
Where do you come up with that 8 percent return? Mutual funds are an excellent place to start. You'll need to invest a hefty portion of your savings in stock funds, choosing a diversified array that includes a range of market sectors -- funds that invest in shares of small and large companies in the U.S. and overseas. Don't restrict your holdings to the most conservative funds. That could prove dangerous, since such funds tend to move up and down in lockstep. Paradoxically, a modest investment in an emerging market fund such as Oppenheimer Developing Markets ($1,000 minimum investment; 5.75 percent load; 800-525-7048) or an aggressive technology fund such as Icon Information Technology Fund ($1,000 minimum, no load; 800-764-0442) could boost your long-term returns while stabilizing your portfolio's behavior in the short-run. Reason: Such funds sometimes march to their own drummer.
That said, maintain some fixed-income holdings to smooth out your returns during periods when the entire stock market is slumping (it happens). Try funds such as Freemont Bond ($2,000 minimum; no load; 800-548-4539) or Harbor Bond ($1,000 minimum; no load; 800-522-1050) which invest in high-quality intermediate-term bonds.
Finally, keep some cash on hand to comfort you during the worst times; that money also will allow you to snap up bargains in battered sectors from time to time. Over the years, those smart moves could help make you a millionaire-even if you don't know the name of the 27th president (William Howard Taft) or when the War of the Roses ended (1485).
