Investing as little as $200 a month can, if you do it consistently and invest wisely, turn into more than $150,000 in as soon as 20 years. If you keep contributing the same amount for another 20 years while generating the same average annual return on your investments, you could have more than $1.2 million. This is why retirement savers are encouraged to start investing early, preferably no later than age 25 or so, in order to have a comfortable nest by the time they reach retirement age about 65. A financial advisor can you develop an investing strategy that fits your retirement plan.
The $200 Monthly Investing Plan
The projections for this model portfolio assume a 10% annual rate of return, which may be more or less than your own investments actually generate. They also don’t account for the impacts of taxes, fees and other factors that can negatively affect the size of your portfolio. For these reasons and a few others, your own results are likely to vary from those in this theoretical example.
Any investor can, however, count on the powerful effect of compounding. A small amount such as $200 can become a six- or even seven-figure amount due mostly to the effect of compound interest. This is the return that is generated from previously generated earnings.
Before too many years go by, the interest generated by your portfolio of investments will outstrip the amount of your monthly contributions. For example, in the eighth year of this $200-a-month investment plan, the total model portfolio will be worth $29,680. That’s $5,178 more than it was worth the previous year, which is more than twice the $2,400 in monthly contributions that were added. In this hypothetical example, after only eight years, compound interest will be generating $2,688. That’s $288 more than more than the total monthly contributions for the year.
Investment Plan Variables
A model portfolio is unlikely to perform identically to a real-world portfolio. One important variable is the rate of return. While this example consistently earns a precise 10% annually, in reality return is certain to fluctuate. Some years it may be significantly more than 10%, while in others is much less. Negative returns are also possible over the course of a year.
Many retirement planners suggest using a more modest annual return of 6% when forecasting the long-term performance of a portfolio. At 6%, after 20 years the $200-a-month portfolio would be worth $93,070. After 40 years earning the same return, your model portfolio would be up to about $398,000.
In addition to rate of return, the other variable that’s been used so far is investment horizon. This is the time in years that will go by before you expect to need the money you are accumulating in your portfolio. Retirement saving usually involves a long investment time horizon measured in decades. Shorter time horizons for goals such as buying a home give compound interest less time to work and yield a smaller total sum.
Asset allocation is another factor, one that is strongly influenced by both investment horizon and your personal risk tolerance. Some assets, such as stocks, yield average 10% annual returns over periods of several decades. However, stocks are risky, meaning that they are subject to unpredictable downturns that may be severe and sometimes long-lasting.
Other assets, such as bonds, are less likely to fluctuate in value but also provide lower long-term returns of about 5%. Most investors have a blend of stocks, bonds and other assets in their portfolios, producing a lower but more stable return. Stability is important because if an investor must liquidate a portfolio for any reason when the market is down, is will seriously reduce total return.
More concerns for the long-term investor include taxes and fees. Federal income taxes can consume up to 37% of returns at the top marginal rate if they are treated as ordinary income, or 15% if taxed as capital gains. And even small fees have a surprisingly large effect on performance over time. Managing an investment portfolio wisely can reduce the impact of both of these by, for example, using low-fee exchange-traded funds (ETFs) and investing within a tax-advantaged account such as an IRA.
If you can invest $200 each and every month and achieve a 10% annual return, in 20 years you’ll have more than $150,000 and, after another 20 years, more than $1.2 million. Your actual rate of return may vary, and you’ll also be affected by taxes, fees and other influences. But the outcome of this investment model shows how compounding interest and consistent savings can produce a comfortable nest egg by retirement, providing you start soon enough.
Investment Planning Tips
- A financial advisor can help you develop a budget to free up $200 to invest each month. It doesn’t have to be hard to find a suitable financial advisor. SmartAsset’s free tool matches you with up to three financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- SmartAsset’s Investment Calculator was used to produce most of these estimated results. The free, online tool lets you input any starting amount, contribution amount, contribution frequency, rate of return and investment time horizon. You can use this tool to produce what-if scenarios and get an idea of how well your long-term investing plan will turn out.
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