Most people need to build significant retirement savings if they want to maintain their lifestyle after they stop working. Social Security provides most people with enough to meet basic needs, but not much more. For most families, any other cash requirements need to be covered by retirement accounts. The best way to 10x retirement savings in two decades is a two-pronged approach: Save regularly and invest those savings for responsible growth.
Step 1: Build consistent savings habits early
No investment strategy can overcome insufficient saving, and you can't build a retirement account without turning earnings into assets.
Consider a hypothetical retirement account with $100,000 worth of securities in its investment portfolio. If no additional contributions are made to the account, then it can only grow through investment returns. In order for that account to grow 10x to $1 million within 20 years, it would need compounding average annual returns of nearly 13%.
Image source: Author's calculations.
It is not reasonable to expect this sort of performance in your retirement account. This would require your allocation to significantly outpace the market as a whole year after year. Even the most accomplished active investors fall short of this performance, and it's not wise for amateur investors to rely on that sort of exceptional performance.
Even if you could devise a world-class strategy that crushes market index returns, you'll still have to deal with shifting portfolio allocation as you approach retirement. As the investment time horizon gets shorter, it's standard practice to increase bond exposure in your retirement account to lock in long-term gains and reduce volatility. This removes the risk that a bear market will wipe out your savings, but it also reduces your investment growth potential.
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If you can contribute $15,000 to that hypothetical retirement account referenced above, then you'll only need an 8% annual rate of return to surpass $1 million in 20 years. That's very achievable, based on historical market performance.
Image source: Author's calculations.
Investment growth is powerful, but there are limitations to its realistic potential.
That's why it's so important to make consistent retirement account contributions. Financial planners generally recommend that households strive to retain 15% to 20% of annual earnings if they want to effectively meet their retirement goals. Not all of those savings have to be directed to retirement accounts -- it's fine to build other assets, such as home equity. However, retirement should still be a high priority in your financial plan.
A 15% to 20% savings rate isn't always feasible, and it's OK if there are times when you fall short of that goal due to unexpected circ*mstances. It's still vital that your financial plan reflects that long-term savings goal and that you are making up for lean times during periods when you have extra cash flow. To maximize retirement savings, make sure that you're using all the resources available to you. Take full advantage of employer 401(k) matching programs if they're offered to you. Use a health savings account (HSA) if you're eligible.
Step 2: Invest for growth
If you're saving the right amount, then a good investment strategy should be more than enough to deliver 10x asset growth. In your earlier working years, your retirement account has the longest possible time horizon -- those funds won't be accessed for multiple decades. That makes short-term volatility and market cycles functionally irrelevant, because you shouldn't have to access those funds and sell stocks when they're down.
A long time horizon allows you to allocate aggressively toward equities and growth assets to maximize returns. You can worry about managing volatility later down the road when it's advantageous to do so. In the meantime, build a balanced equity portfolio with relatively heavy growth stock exposure to maximize long-term returns.
Consider the hypothetical retirement account from before. If it was invested too conservatively and returned only 4% annually, then it wouldn't even grow to $650,000 over 20 years, even with $15,000 being contributed each year.
Image source: Author's calculations.
Don't take unwise risks with your retirement savings, but don't be scared to exchange volatility for growth. A properly diversified portfolio of equities might go through ups and downs over the years, but it should provide plenty of long-term upside. As long as you don't sell when the market is down, history tells us that the market will eventually recover and deliver returns for shareholders.
