How to Invest $500 a Month and Become a Millionaire in 30 Years | The motley fool (2024)

If you have $500 left at the end of each month, you can easily become a millionaireeasy access to investmentsand a little patience. If you simply compare historical stock market returns over the past ninety years (returns averaging 10% per year), an investment of $500 per month will earn you over $1 million over thirty years.

But it's one thing to understand the power ofcompound growthInthe dollar cost average(we'll talk more about both later); it's another to develop a plan for how to take advantage of it. You will learn it in this articlesome strategiesto invest $500 a month and become a millionaire when you are ready to retire.

Some requirements for investing $500 per month

For youstart investingyour money inthe stock market, there are a few things you should have in place.

Pay off your high interest debt

Creditcardschuld, unpaid medical bills, and even some student loans can be a major drag on your finances, especially when interest rates are in the double digits. Everyone's definition of high interest debt will be different, but I would consider anything above 6% worth paying off before investing.

The reason forrepayment of debtsthe first is simple: it is essentially a guaranteed return on investment. Plus, after you pay off your debt, you'll have more money to invest each month because you don't have to pay interest.

Here's the best way to spend your $500 each month to pay off your debt:

1. Organize all your debts, from the smallest balance to the largest.
2. Pay the minimum amount on all debts.
3. Use the money you have left to pay the minimum balance.
4. Once you pay off the smallest balance, you can make larger payments on the next smallest balance.
5. Repeat this until all your debts are gone.

This is called the 'snowball method'. It's not mathematically optimal, but the psychological boost of paying off these smaller balances keeps people motivated to keep paying off their debts.

Create an emergency fund

If you don't have anything saved for emergencies, it probably makes sense to set something up like thisemergency fund. It doesn't have to be big. You can start with as little as $1,000 to handle common events like unexpected car or home repairs or unplanned but necessary trips. Most experts recommend three to six months of life support, depending on your circ*mstances and risk profile.

The safest place to keep your emergency fund is in a savings account. It doesn't provide much return at current interest rates, but it does provide the necessary security to reduce the risk of falling into debt or having to take on debt.handle investmentsat an inopportune time.

It's worth taking the time to build a solid financial foundation before investing your savings.

Compound Growth: The Most Powerful Force in the Universe?

If you areinterested in investing, which you probably already know something aboutcompound growth. But just to make sure we're all on the same page, here's a simple example of howinvest todaywill allow compounding to grow your money tremendously over the next 30 years.

If you invested $500 and earned 10% over the next year, you would have $550. The math is simple: 10% of $500 is $50.

Compound growth means that you leave this surplus in the account so that the money you earned last year can make money again this year. So in the second year, your $500 would earn $50 again, and the $50 in profits you made the previous year would earn another $5, for a total of $55. You end the second year with $605. The next year you would earn another $60 and the year after that $66.

It only really starts to add up when your profits increase more often. If, instead of receiving a large payment of $50 at the end of the year, you received a payment every month, those payments could start producing their own growth more quickly; after a year you will have even more money.

Each compounding period will make your cash pile more and more money. In the 30th year of our example above, your original investment of $500 would earn you $793. That's more than the initial investment! It's no wonder that Albert Einstein is said to have declared compound interest the most powerful force in the universe.

Cost average in dollars

While it would be great if you could count on 10% interest in the stock market year in and year out, the real world doesn't work that way. Thatthe market has its ups and setbacksevery day, month and year.

Although the long-term trend in the market is an increase in value, it is impossible to know whether the market will rise or fall in any given month or year. Using a simple strategy calledthe dollar cost averagecan help you navigate the ups and downs of the market.

Cost average in dollarsIt simply involves investing a fixed dollar amount - e.g. $500 - on a regular schedule - maybe every month. This way you buy more shares when the market falls and fewer shares when the price rises. Ultimately, your average cost basis will be below the market average because you end up buying more shares at the lower price and fewer shares at the higher prices.

Calculating costs in dollars can reduce the emotional response to investing. It's a simple plan to follow and after a while it becomes relatively mechanical. Some investment accounts even let you invest on autopilot, so you don't even have to think about it. Investors who use dollar cost averaging are not constantly looking for a good entry point or doubting their purchases. They simply repeat the process every month.

Developing a simple system that works is the key to sticking to a financial plan. Calculating costs in dollars is as simple as it gets.

The easiest way to invest €500 per month

For those who don't want to worry about things likeasset allocation,rebalancing a portfolio, or the ability to access money, there is an easy way to invest $500 per month. (Fair warning: This isn't the most efficient way to invest, but it may be the easiest.)

You can put this $500 a month into onetarget date fundwith any mutual fund such as Vanguard, Fidelity orT. Rowe Price. INinvestment associationis a collection of shares andbonds, usually managed by a designated portfolio manager. Buy oneshare of an investment associationmeans that you buy part of the fund's portfolio.

Meal funds are special investment funds with a targeted asset allocation based on your planned retirement date. The fund manager will automatically rebalance the portfolio to match this allocation, without requiring shareholders to make any changes. These funds can be good for people who are short on time or who don't want to do more research than necessary.

To start investing in a mutual fund, simplyopen a securities accountand choose the fund that suits your desired retirement date. Link your bank account details to fund the account, and you can even commit to automatically investing $500 per month in the same fund.

Some funds have minimum investment requirements, but setting up automatic monthly investments usually lowers these minimums well below $500 per share. month.

Investing this way is dead simple, but you may end up paying more taxes in the long runcapital gains. Capital gains are the profits from the sale of an investment – ​​and just like the profits you make from your job,the government wants a share. With mutual funds, the portfolio manager may eventually sell highly valued assets to rebalance the portfolio and create capital gains. You'll probably be better off using a deferred retirement account for your investments.

You can save even more with a company-sponsored retirement plan

Many companies offer one401(k) retirement planfor their employees, and some even offer an incentive to contribute. Often a company will provide onematching contributionto an employee's 401(k), equal to a percentage of the employee's salary.

For example, if you earn $50,000 and your company offers a 4% matching contribution, the company will match the first $2,000 you contribute to your 401(k). The percentage of your contribution that an employer will match typically ranges from 50% to 200%.

The 401(k) match is something you never want to miss. It's free money.

A 401(k) account usually has limited investment choices and relativelyhigh fees. While these can reduce your returns over the years, a matching contribution will more than offset the higher costs associated with the account. Such accounts typically contain multiple target funds, which should also match your goals.

You fund your 401(k) throughdeduct salary. Simply contact your HR department and tell them that you will contribute €500 per month (or whatever amount you prefer); that money goes directly into your 401(k). This can make investing $500 a month much easier because it takes one step away from you once you get everything set up.

In addition to the potential free money from an employer, 401(k) accounts are tax-advantaged. You can deduct premiums from your income tax. This way you can actually save even more. The government also puts some extra money in your pocket. Additionally, the funds in a traditional 401(k) grow tax-free, so if you end up buying or selling stocks, or if the fund you invest in distributes capital gains, you don't have to worry about paying taxes on the stock's growth . your shares. You only pay tax when you withdraw money.

Your employer may also offer oneRoth 401(k). With a Roth, instead of taking a tax deduction on your income taxes for your 401(k) contributions, you pay taxes now, but then don't have to pay taxes on your withdrawals.

Which one is right for you – traditional or Roth – depends on your personal situation and expectations for the future. Practically speaking, if you expect your effective tax rate to be higher than yours in retirementmarginal tax ratetoday you need a Roth. Otherwise, choose a traditional 401(k).Traditional will work best for most people.

Use an IRA for more control

Aindividual retirement account(IRA) can give you even more control over your investments. IRAs also come in traditional and Roth varieties and have the same tax benefits as a 401(k). However, unlike 401(k)s, IRAs have many more investment options. Most of the things you can invest in are within onetypical brokerage accountis also fair game in an IRA; this means you have your choice of funds.

However, if you plan to save $500 per month, you will encounter a small problem. Thatmaximum contributions to an IRA in 2018amounts to only $5,500. At the end of each year, you'll be left with $500, which won't go into your IRA unless you qualify for an additional $1,000 in catch-up contributions (for investors age 50 or older).

The extra $500 could go toward a regular brokerage account, but that complicates the plan a bit. The IRS occasionally increases contribution limits on retirement accounts to account for inflation, so you can eventually contribute as much as $6,000 per year to your IRA.

The disadvantages of retirement accounts

The biggest disadvantage of investing all your money in a retirement account like an IRA or a 401(k) is that you have limited access to your money. IRAs don't let you do thatwithdraw your moneypenalty-free up to age 59 1/2. Although 401(k)s have a similar rule, they can allow thisgain access to your money at age 54if you leave employment during the calendar year, you will be 55 years old or later.

There are some ways to get around the withdrawal rules, such as by usingapproximately equal periodic paymentsor just pay the 10%penalty for early termination. But for the most part, you shouldn't expect to have access to these funds until retirement age.

Roth accounts are a little different. You can withdraw yourscontributionto Roth accounts at any time, without penalties. Thatgainhowever, your investment still remains fixed until you are 59 1/2. like youconvert money from a traditional IRA to a Roth IRA, the converted amount will be available for withdrawal after five years.

Another potential downside to 401(k) accounts is that yours may have a poor selection of funds to choose from, and account fees may be relatively high. Still, it is worth investing in them for the employer match, and that is possibleroll over the moneyin an IRA when you separate from service.

For the optimizers

For those who want to goin addition to target date fundsIf you choose a few index funds of your own, you can save some money in the form of rebatescost ratio. The expense ratio is the percentage of your investment that the fund company keeps for itself in exchange for managing the funds. The average expense ratio of a target fund is 0.44%, compared to 0.09% for simple index funds. And that difference of 0.35 percentage points increases sharply over time.

Mutual funds simply consist of several index funds that are rebalanced on a regular schedule so that each fund accounts for a certain target percentage of the portfolio. Aindex fundsis a simple mutual fund that tracks an index by purchasing all the securities in the index. For example, aS&P500the index fund will own shares of the 500 US companies included in the S&P 500 index.

Each target fund tells you which index funds it invests in and what its target allocations are. You should also be able to find the fund company's planned glide path for its target date funds. A “glide path” is the plan to change asset allocation over time as you get closer to retirement.

Because you add money to your account every month, you can allocate it in a way that keeps your portfolio closer to your target asset allocation, without having to sell shares in one fund to buy shares in another fund and redeploy them. to bring balance. It minimizes yourcapital gains tax, in addition to saving the higher expense ratios associated with target funds versus standard index funds.

If you want to do even more research and develop an appropriate asset allocation for yourself and your personal risk profile, you may get better results than the cookie-cutter plan for people retiring in 30 or 40 years that you would get with fund allocations on target date. . It's up to you to decide whether a fraction of a percentage point in additional returns is worth the time it takes to do additional research.

A step-by-step plan

Now that you understand the basics of compound growth and dollar cost calculations,available types of accountsfor you and yoursinvestment opportunities, here is a step-by-step guide on how to invest $500 per month:

1. Open onebrokerage accountwith the fund company of your choice or enroll in your company's 401(k) plan. Do some research to find the target date or index funds that best suit your style and have the lowest costs.
2. Give your bank details to your broker or fill out some paperwork at your company and automatically create €500 deposits every month.
3. Select the fund(s) in which you want to invest. If you invest in a target fund, you can set $500 to automatically buy more shares of your chosen fund. If you manage your own asset allocation, you'll probably still want to manually buy shares every month so you can keep yoursportfolio in balancewith your target allocation.

That is it.

Investing doesn't have to be more complicated than that.

How much is $500 per month?

At the beginning of this article I told you about investing$500 per monthimmediatelyaverage returnof 10% per year will result in a portfolio of $1.14 million after 30 years. But the market may not continue to return 10% and if you invest in moredifferent asset classesTo reduce volatility, your 30-year performance will likely underperform overall stock market returns.

Here you can see how much you can expect at different return levels (compounded monthly) if you invest €500 per month. month.

Data source: Calculations per author.

It's also important to keep in mind that these numbers are in today's dollars. Thanks to inflation, $1 million in thirty years won't be worth as much as it is today.

Put money away consistentlyGetting into the market regularly – even if it's just $500 a month – and investing in low-cost index funds is the easiest way to become a millionaire. Even from nothing you can reach millionaire status within 30 years. And if you can increase that $500 per month over time to keep up with inflation, you'll get there even faster.