Becoming a millionaire is often considered a financial milestone in America -- crossing the seven-figure mark for net worth puts you in the top 3% of the U.S. population, according to research firm Spectrem. But a million dollars still might not be enough for a comfortable retirement.
A recent survey by Ameriprise Financial found that just 13% of Americans with over $1 million in investable assets considered themselves wealthy. Another survey by Charles Schwab found that most Americans believe that they needed an average of $1.7 million to retire.
That isn't surprising since the average annual inflation rate of about 3% over the past century has greatly reduced the purchasing power of $1 million. The easiest way to offset that inflation is to invest your cash in a well-diversified portfolio of bonds, stocks, and funds. Let's discuss the smartest ways to invest $1 million in today's market.
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Determining the right split between cash, bonds, and stocks
Most investors should maintain a cash position equivalent to at least six months of expenses. The Bureau of Labor Statistics estimates that the average household led by a retiree spends about $3,800 per month.
This means that the average retiree should have at least $22,800 in cash on hand. In other words, most people should keep a cash position of just 2%-3% in a million-dollar portfolio. The rest should be split between bonds and stocks.
The classic model for determining the percentage of your portfolio to allocate toward stocks is based on subtracting your age from 100. But since people live longer than they did a few decades ago, most financial advisers will recommend subtracting your age from 120 instead.
Buying the right stocks or funds
Therefore, it's natural for new millionaires to maintain a $500,000 portfolio of stocks, ETFs, mutual funds, and index funds. Younger millionaires can consider investing in higher-growth stocks or funds, while retirees should buy more conservative income stocks.
Good evergreen plays for both younger and older investors include Coca-Cola (NYSE: KO), the beverage giant that's raised its annual dividend for 56 straight years; the Vanguard 500 Index Fund Investor Shares (NASDAQMUTFUND: VFINX) index fund, which tracks the S&P 500 with a low expense ratio of 0.14%; and the Invesco QQQ Trust (NASDAQ: QQQ) ETF, which offers broad exposure to top tech stocks with a low expense ratio of 0.2%.
Note: Price percent change over the past decade. Source: YCharts
Investors should also decide what to do with the dividends. Younger investors should enroll all their dividend-bearing investments into dividend reinvestment plans (DRIPs) to compound gains over time. Retirees might consider enrolling some stocks in DRIPs while using others to generate stable income.
Choosing the right bonds
When choosing bonds, investors should pay attention to four main things: their credit ratings, yields, maturity dates, and market prices. Some bonds are also callable, which means that they can be redeemed for cash before the maturity date.
Bonds with lower credit ratings or more distant maturity dates pay higher yields, but investors should be careful when it comes to "junk bonds" with ratings of "BB" or lower from Standard & Poor's and "Ba" or lower from Moody's. Treasury and municipal bonds also typically have higher ratings (but lower yields) than corporate bonds. Generally speaking, investors should buy bonds with yields that keep pace with inflation, have investment-grade ratings, and trade near their par values (or a price of $100).
Investors who don't want to do all that homework should either stick with long-term treasuries or buy a diversified bond fund like the Vanguard Total Bond Market ETF (NASDAQ: BND), which owns a diverse basket of bonds, charges a low expense ratio of 0.035%, and pays a yield of 2.7%.
The bottom line
Keeping a million dollars in a diversified portfolio of stocks and bonds ensures that your savings keep pace with inflation. Some promising stocks could also generate massive returns along the way -- and make you feel richer than the majority of newly minted millionaires in America.
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Leo Sun has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Moody's. The Motley Fool owns shares of Vanguard Total Bond Market ETF. The Motley Fool has a disclosure policy.
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