How Small Investments Can Grow Into a Large Retirement Nest Egg

When Individual Retirement Accounts (IRAs) became a long-term retirement investment option in the United States, as part of the 1986 Tax Reform Act, many proponents predicted it would result in numerous people becoming millionaires by the time they reached retirement age. It may be hard to believe, but those predictions are entirely correct, as long as the maximum $3,000 per year contribution to an IRA is made each year and the money is invested in dividend paying stocks that provide high rates of return. Even relatively modest contributions of $50 per month ($600 per year) to an IRA can grown into a considerable retirement nest egg over a lifetime of working. The likely investment returns that can be earned by making long-term investments are not wishful thinking, they are based on historical stock market returns and hard math.

The stock market has historically returned approximately 9% on average per year when stocks are held over long periods of time. This average annual return includes both nominal stock price gains and dividends paid based on stock ownership (receiving stock dividends is the key to increasing stock market returns). It is important to note that the stock market is highly volatile and 9% annual returns do not occur every year, with some years well below or above this average, and some years experiencing losses. To capture the average 9% annual stock market return, an investment portfolio needs to be continuously invested in the stock market to ensure the above average years’ gains are captured and invested in dividend paying stocks to capture the additional returns provided by stock dividends. Dividends on stocks should be reinvested in the stocks to maximize long term gains.

Investing $3,000 per year in dividend paying stocks via an Individual Retirement Account (IRA) for forty years would turn into $1,104,875 at a 9% annual rate of return that is compounded annually. That would be $120,000 invested over forty years that turns a retiree into a millionaire with a $1,104,875 in their Individual Retirement Account (IRA). The total amount could be even higher, if dividends from dividend paying stocks are reinvested.

Since $3,000 per year may be too much for many middle income people to set aside and invest each year for retirement, it is important to understand that even small investments in dividend paying stocks of $50 per month ($600 per year) can turn into a sizeable $220,975 retirement nest egg over forty years. That is $24,000 invested over forty years turned into $220,975 by the time one is ready to retire. This calculation assumes a 9% annual rate of return from stock investments that is compounded annually. The key to achieving such large gains from small monthly investments is to keep the money invested in the stock market during its ups and downs to capture the years with above average returns and invest in dividend paying stocks to the receive the additional returns provide by stock dividends.

A critical retirement investing error that too many investors make is keeping their retirement nest egg in the volatile stock market after they retire. The stock market has experienced two significant meltdowns since the year 2000, and some retirees lost a considerable amount of money during these steep stock market selloffs. It is important to shift money out of volatile stocks upon retirement or ahead of retirement to ensure that a retirement nest egg retains its value and is available during retirement. Financial advisors often suggest shifting money from volatile stocks to safe interest paying financial instruments, such as investment grade bonds, government bonds, or annuities. The key to investing during retirement is to hold onto investment gains made over a lifetime of working and use a retirement nest egg to provide income that is needed during retirement.

Disclaimer: This article was not written by a financial professional or a registered financial advisor. This article is for informational purposes only, and is not intended to be solicitation or recommendation to purchase stocks or any financial products. Please consult a registered financial advisor to ensure you understand the risks and rewards associated with buying and selling stocks and other financial products.