How to Retire Rich

5 Tips for Making the Most of Your Investments

Happy retired couple in autumn setting
••• Tom Merton / Getty Images

Many people only begin investing because they are thinking ahead to retirement. It's not that they desire passive income today, but rather they plan on continuing to work throughout their career and want to make sure they have plenty when they can no longer show up to the office or punch a time clock.

If they plan well, they'll never have to worry about putting food on the table, affording prescription medications, having a place to live, or paying for the things that provide entertainment and enjoyment in their lives.

One fantastic example of what is possible when you think long-term and arrange your financial affairs wisely is Anne Scheiber, the retired IRS agent who amassed a fortune that, in 2020 inflation-adjusted dollars, would be worth over $38 million. She did it starting with only a small amount of savings and a modest income of $4,000, building each position in her portfolio from the tiny apartment in New York City that she called home.

Another example is janitor Ronald Read, who earned near-minimum wage working at Sears. When he died, it was uncovered that he had quietly accumulated more than $8 million in blue-chip stocks. The list goes on and on, but the point is the same. Many of these people were not necessarily exceptional in terms of intelligence or the number of hours they worked. Rather, they took advantage of the power of compounding, gave themselves a long stretch to let their money grow, and focused on reducing risk.

Key Takeaways

Here are a few key strategies to help you retire rich:

  • Understand that time is money—the sooner you invest, the better.
  • Max out your IRA contributions.
  • Use your full employer match on your 401(k).
  • Roll your 401(k) into another 401(k) or rollover IRA when you leave your job.
  • Invest in high-performing companies.

Understand That Time Is Money

The most important key to retiring rich is to start investing as early as possible and then to live as long as possible. Many workers, strapped for cash or eying a major purchase, tell themselves that they can make up for lost time by making higher contributions in future years. Unfortunately, money doesn’t work that way. Thanks to the power of compounding, cash invested today has a disproportionate impact on your wealth level at retirement.

To put the matter into perspective, consider two possible scenarios. Both assume that our hypothetical investor retires at 65 and enjoys an annual compounded rate of return of 10%, which is generally considered ordinary and satisfactory for equities over long periods of time.

John is 40 years old and invests $20,000 a year for retirement. Charlotte is 21 years old and invests $5,000 a year for retirement. By the time each of these individuals retires at age 65, they will have invested $500,000 and $220,000 respectively. Yet, because of the power of compound interest, John would retire with about 60% of the money that Charlotte would have, despite investing more than twice as much. The moral of the story? Stop robbing your future to pay for today.  

Take Full Advantage of Employer Matching on Your 401(k)

Many companies will match a significant portion of your earnings based on the contributions you make to your 401(k) plan. If you are fortunate enough to work for such a business—and many Americans are—use it to the fullest. If you don’t, you are walking away from free money. Even if all you do is have your 401(k) contributions parked in cash and cash equivalents, it's often an instant, practically risk-free 50% to 100% return.

Whenever possible, you should make contributions to your 401(k) all the way up to your employer's matching limit.

Max Out the Annual IRA Contribution Limit

After maxing out your 401(k) contributions, or if you don't have access to any employer-sponsored retirement vehicles, shift your attention to an IRA.

When it comes to IRA contribution limits, Uncle Sam’s motto seems to be “Use it or lose it.” Workers who haven’t made the maximum permissible contribution to their traditional or Roth IRA by the cutoff date are flat out of luck unless they are in their 50s and qualify for something known as a "catch-up contribution."

In 2020 and 2021, the maximum annual contribution to an IRA is $6,000 for workers under age 50 and $7,000 for workers age 50 or older.

IRAs allow you to enjoy either tax-deferred or tax-free growth, depending upon the type of IRA you use. That, in turn, allows you to use strategies such as asset placement. A Roth IRA is the closest thing to a perfect tax shelter that exists in the United States. As long as you follow the rules, you can effectively avoid paying taxes on any of your capital gains or dividends for life.

IRAs also have different types of asset-protection levels. Traditional and Roth IRAs, by way of illustration, are generally protected from creditors for amounts up to roughly $1.36 million in the event of a bankruptcy, with only a few types of liabilities being able to invade the protection, including tax liens and divorce settlements. Other types of IRAs have no limit on the amount of bankruptcy protection they offer.

Use a Rollover IRA to Retire Rich

If you are anything like the average American worker, the odds are fairly substantial you will change jobs at some point during your career. When that occurs, the most unwise thing you could possibly do under most circumstances is to cash out of your retirement investments.

Instead, roll over the proceeds into a rollover IRA or your new employer’s 401(k) plan. In addition to avoiding the significant taxes and early withdrawal penalties that you otherwise might have incurred, you will be able to keep your money working for you tax-free or tax-deferred, making it a lot more likely that you'll reach retirement with more money than you otherwise would have had.

Given enough time—you already saw the power that a few decades can have on seemingly small amounts of money—that could mean the difference between vacationing in Tahiti and having to take a part-time job to supplement your income.

Buy Productive Assets to Retire Rich

Ultimately, for most people, the best way to get rich by retirement is to get your hands on productive assets, particularly equity stakes in excellent businesses. A stake in an impressive business, bought at a low price, can work wonders. The general public often focuses on short-term market value—usually defined as anything less than five years—and, in the process, misses the forest for the trees.

Look at a company like The Hershey Company. Between 2005 and 2009, the stock lost about 50% of its value, slowly declining despite profits being fine, dividends increasing, and the price-to-earnings ratio, PEG ratio, and dividend-adjusted PEG ratio all being in good shape. It would have been tempting to sell your stock during that fall, but you'd have been unwise to sell it or even lose a moment's sleep over it, given the company's market share and returns on capital.

Hershey is a business that has been around for more than a century and has survived recent calamities such as the dot-com bubble and the 2007–2009 collapse. As of November 2020, the firm has paid dividends for 364 consecutive quarters—an uninterrupted chain of checks sent out to owners, going back generations.

Consider this: Imagine that it is July 1985. Hershey is the largest chocolate company in the country, a name that practically every citizen knows. You decide you want to buy $100,000 worth of stock in it. As of November 2020, that stake would have a market value of $7.8 million, and that doesn't include dividends paid out every quarter in that period. It also assumes that you didn't reinvest any of those dividends or buy any additional shares. As you can see, that's quite a return.

Find your Hershey. There are often things right in front of you, things that you know have a low chance of losing money over long periods of time and are no-brainers. Take advantage of your specialized knowledge. Make sure you have ample diversification to protect yourself if you're wrong. Don't buy stocks on margin. It isn't that complex. Time and compounding will do the heavy lifting if you let them. You have to plant the right seeds in the right soil and then get out of the way.