There isn’t much about the future that I can predict — much less guarantee — to investors.
But here’s one thing I can guarantee: If you achieve as little as an extra 0.5% in annualized return while you’re accumulating assets — and continue to do so during retirement — you will be many, many dollars ahead.
That difference can change your life, as well as the lives of your eventual heirs.
Much of your investment return is determined by things outside your control:
- Were you fortunate enough to be born into a family that provided a good education, strong financial examples, or even a trust fund?
- Or did you have to scramble for every dollar and every advantage?
- When you’re near retirement, does the market suddenly take a major downturn and force you to say goodbye to a large portion of what you’ve saved?
Those factors — along with health and longevity — certainly shape your financial future.
But how well you do financially also depends on how effectively you play the hand you’re dealt. A good place to start is understanding just how powerful a seemingly small 0.5% difference can be over time.
Imagine that you and your twin sister are celebrating your 21st birthday. You each invest $5,000 and add the same amount every year on your birthday until age 67.
Now assume that, for whatever reason, your sister earns an annual return of 8.5% over that period, while your return is 8%.
Let’s ignore taxes and assume all of this takes place inside Roth IRAs.
Your first investment occurs at age 21, and your last at age 66 — 46 investments in total — costing each of you $230,000.
On your 67th birthday, you compare balances as you prepare to take your first retirement withdrawal of 4% per year.
Your Roth IRA is worth about $2,259,500. Your sister’s is worth about $2,657,300 — nearly $400,000 more. That difference alone exceeds all the annual contributions either of you made.
This is the first of three financial advantages your sister enjoys from earning an extra 0.5%.
Your first 4% withdrawal equals $90,380. Your sister’s is $106,292 — a meaningful increase in retirement income from the very start.
Now assume both of you live to age 97, scale back risk in retirement, and that your sister continues to earn 0.5% more than you.
If your portfolio earns 6% during retirement while you withdraw 4% annually, you will have withdrawn a total of $3.54 million by age 96.
Your sister’s total withdrawals will equal $4.48 million.
So far, that extra 0.5% has been worth nearly $950,000.
Now consider what’s left at age 97.
Your Roth IRA balance would be about $3.81 million.
Your sister’s would be about $5.16 million.
Here’s the final score:
- Your total withdrawals plus remaining balance: $7.35 million
- Your sister’s total: $9.64 million
That $2.3 million difference came from just one thing: an extra 0.5% return over a lifetime.
I can’t guarantee specific returns like 8%, 8.5%, or 6%.
But I can guarantee that an extra 0.5% will make a dramatic difference — and that there are simple, practical ways to capture it.
Here are three places to find that advantage:
- Lower expenses. Actively managed funds often charge about 1% per year. Index funds typically charge less than half that.
- Increase equity exposure. Over the past 50 years, increasing equity exposure from 50% to 60% has added more than 0.5% in annual return.
- Diversify wisely. Go beyond the S&P 500 by adding asset classes with long histories of higher returns and little additional risk.
That third step — diversification — is one of the smartest decisions investors can make.
These steps are simple. They are fully within your control. And over time, they can make an enormous difference.
As the numbers show, little things really do mean a lot.
Guaranteed.
Richard Buck and Daryl Bahls contributed to this article.