Investment Tips for Growing Your Retirement Savings to $1 Million

Key Takeaways

  • Compound interest and diversification are two of the most important attributes of successful investing.
  • Investing as early as possible is key to harnessing the power of compound growth.
  • Balancing your portfolio to avoid country or sector overconcentration is key to avoiding additional risk and benefiting from broader market opportunities.

If we were to teach you a retirement strategy to help raise the value of your retirement portfolio to one million dollars, our first lesson wouldn’t be about stocks, bonds, mutual funds, annuity products or even account types. Neither would it be about sidestepping bear markets, maximizing social security or taking advantage of different types of retirement accounts. Instead, it would focus on two things many investors overlook: compound interest and diversification.

Compound interest means earning interest on your previously earned interest over time, and it is one of the strongest forces in investing. It can power a longer-term investment strategy, cultivate growth over a period of years and transform a relatively modest investment into a large retirement portfolio.

Diversification is the key to generating portfolio growth across different economic conditions and cycles. It involves spreading your portfolio across many companies, sectors, countries and more to potentially avoid overconcentration in any single area.

Whether your goal—after you retire—is to have enough for retirement or leave a generous legacy, generating compound growth and participating in the market over multiple cycles are key to expanding the value of your retirement portfolio in the long term.

The Power of Compound Interest

The idea behind compound interest is relatively simple. You invest a certain sum, it earns a return, you reinvest that return, that larger sum earns a return and you repeat. Exhibit 1 shows how over long periods of time, compound interest can have a huge impact on your savings.

Exhibit 1: $4,000 Annual Contributions Compounding for 30 Years at Various Rates

Note: Hypothetical returns show for illustrative purposes only and not a representation of past performance.

After 30 years of saving $4,000 annually, you would have contributed $120,000. But with a growth rate of 8%, that $120,000 would have grown to $489,383. Even with a 4% annualized return—a somewhat low growth rate for a 30-year investment—you still would have doubled your principal investment. This long-term rise is amplified due to the power of compound growth.

Start Retirement Planning ASAP

Retirement planning is a long-term process. Even if you are already a retiree, you may still have 20 or 30 years to continue building your retirement. So, maintaining a retirement strategy that harnesses compound growth—even if you are a retiree who is no longer contributing—may still be key. Compounding can be just as important over those 20 to 30 years as it is for those who are just starting their retirement saving journey.

One common example used to illustrate the importance of compound interest is saving in your 20s versus saving in your 30s until retirement. (Both are important, but this is for illustrative purposes.) Exhibit 2 tells the story of two hypothetical savers, Bill and Ted. Bill starts his retirement investing at 22 and Ted waits until 30.

Exhibit 2: The Cost of Waiting to Invest in Retirement Planning

Note: Hypothetical returns show for illustrative purposes only and not a representation of past performance.

The eight years Ted waited to begin investing in his retirement made a difference: His portfolio for retirement is smaller than Bill’s by more than half a million dollars. Bill gained the extra half-million by investing only $32,000 in those first eight years.

For Ted to reach Bill’s $1.2 million portfolio by age 62, he would have to invest twice as much annually ($8,000). But if that were the case:

  • Ted’s total principal invested would be $320,000.
  • Bill’s total principal invested would be only $164,000.

Bear in mind this example is hypothetical and meant to demonstrate the impact of compound interest. Starting early is a crucial part of a meeting your retirement goals. The later you start to contribute to your retirement savings, the more catching up you may have to do later on.

Perhaps just as important as investing as early as possible, is making sure that your retirement portfolio is diversified.

Diversification for Retirement Planning

Diversification comes in many forms, but when it comes to planning your portfolio, there are at least two we highly recommend monitoring: Country diversification and sector diversification.

A successful diversification strategy isn’t necessarily about owning multiple types of securities, such as stocks, bonds, cash, mutual funds or exchange -traded funds (ETFs). It may be more about spreading your portfolio across companies with varying characteristics and fundamental drivers—like countries and sectors.

Country Diversification

Country diversification means investing your assets across multiple nations. Exposure to multiple countries offsets the risks of investing in a single country such as, crises (such as war or oil shortages) and unexpected events (political policy changes or natural disasters).

Failing to invest across country lines can mean missing large growth opportunities as well. The US has only been one of the top five best performing developed countries in six of the last 20 years. Meaning some of the best growth opportunities have been outside of the US for 14 of those years. Needless to say, it can pay to invest in non-US stocks.

Sector Diversification

Sector diversification is similar to country diversification, but involves a larger segment of related industries and businesses. Remember the tech bubble of 2000? If investors take one lesson from this, it should be to spread your investments across many sectors.

In 2000, technology stocks skyrocketed and crashed in near-uniformity. Bank stocks were hit especially hard in 2008. When energy prices plummeted in 2014, energy stocks felt the pain shortly after.

How would you know if you are too concentrated by sector? Compare the weight of your portfolio to the broader market. For instance, if you invest globally, you might want to compare with your sector weighting to the MSCI World Index’s sector weights. Exhibit 3 shows the weightings as of 3/31/2019.

Exhibit 3: MSCI World Index Sector Weights

The portfolio shown above reflects the MSCI World Index as of 03/31/2019. The MSCI World Index measures the performance of selected stocks in 23 developed countries. Values may not sum to 100% due to rounding.

The MSCI World Index sector weightings represent what broader developed-world market looks like on a sector basis and can help determine if you might be overconcentrated in any one sector.

If your diversification goal is to match the broader market, then distributing an equal weighting to each sector in your portfolio would not necessarily resemble the actual market.

Fisher Investments uses broad, market-capitalization (company-size) weighted indexes as guides for retirement planning portfolio construction or to construct other investing strategies as well. Depending on our forecast of a given sector or the market in general, we can overweight and underweight different sectors to balance a portfolio’s sector exposure.

For example, if we have a positive outlook on health care stocks, perhaps we will hold more than the benchmark’s weight. If we are not optimistic, we may hold less.

Why hold any health care stocks if you aren’t optimistic about them? In the market, there is no certainty. Hence, throwing caution to the wind and placing all your investment money on a narrow bet would be extremely risky and not a very sound retirement strategy.

There are times when the market can be a harsh and humbling teacher. Diversifying is all about creating staying disciplined.

Compound Growth and Diversification to Boost Retirement Savings

When you retire, you need to make sure you have enough income, cash flow and savings to live the retiree lifestyle you envision. Planning and investing early is key to a successful retirement.

Another factor that could affect you when you retire is inflation. Inflation decreases purchasing power over time and erodes real savings and investment returns. Many investors fail to realize how much of an impact inflation can have. Since 1925, inflation has averaged about 3% a year. If that average rate continues, a person who currently requires $50,000 to cover annual living expenses would need approximately $90,000 in 20 years and about $120,000 in 30 years.

Fixed-income payments, such as those offered by bonds, social security and certain annuity contracts may not be able to keep up with the pace of inflation. Some annuity contracts offer additional inflation rider benefits, but at a cost that may also erode your total returns.

portfolio of well-diversified equities experiencing compound growth, on the other hand, may help keep your portfolio at pace with or ahead of inflation’s rise. It could provide the kind of investment returns and cash flow you need once you retire.

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Investing in securities involves a risk of loss. Past performance is never a guarantee of future returns. Investing in foreign stock markets involves additional risks, such as the risk of currency fluctuations.