The big four-oh is a milestone birthday that slaps even the youngest at heart with indisputable proof that middle age has tracked them down at last. It also calls for a reckoning about your retirement readiness.
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The usual discussion focuses on how much money a person should have saved at a given age, but what share of those savings should be put to work in the stock market in pursuit of gains with the risk of loss?
There’s no one right answer as to how much a person should have invested in stocks by age 40, but there are some guidelines you can follow to find your magic number.
You Can’t Name a Dollar Figure, but $500,000 Is a Good One
Because people who earn more have the potential to save more, the question of how much you should have in stocks can be answered only with a percentage of income, not a dollar amount.
But Greg Wilson, a chartered financial analyst with more than 22 years of experience in financial services, managed to come up with one: $500,000.
“I am a big advocate of maxing out a 401(k),” said Wilson, founder of the personal finance sites Cha Ching Queen and Dad Is Fire. “It’s hard to do, but I look at it like taxes. You have to pay your taxes and you need to fully fund your 401(k). If someone were to max out their 401(k), they should have at least $500,000 in it by the time they are 40.”
$18,000 a Year for 18 Years
Wilson calls the path to a half-million dollars in the first half of life a “time value” proposition.
If a 22-year-old maxes out a 401(k) until age 40, the employee would put roughly $18,000 into the stock market every year for 18 years. That number comes from the average maximum annual contribution, which increased gradually from $14,000 in 2005 to $22,500 in 2023.
An average of $18,000 per year for 18 years is $324,000, which, presuming a 6% annualized rate of return, would grow into a cool half-million hard at work in a retirement fund — or maybe even more — by age 40.
“The $500,000 is conservative,” Wilson said. “It doesn’t factor in employee matches, larger, more normal returns, etc. Obviously, this is a very large number for most people to do early or even in the middle of their career, but funding your retirement needs to be a priority over things like bigger houses and expensive cars. If you can’t max out your 401(k) in your 20s, then try. Future you will thank you.”
Start With 3 Times Your Salary
Wilson’s $500,000 storyline illustrates the power of time and compounding, but it outlines an unlikely and arbitrary best-case scenario. Presumably, most 20-somethings just entering the labor force don’t earn enough to max out their 401(k)s. Therefore, most financial advisors gauge their clients’ readiness for retirement not by a specific dollar amount, but by a multiplier of their income relative to their age.
According to Ally Bank, “The general rule of thumb for how much retirement savings you should have by age 40 is three times your household income.”
The median salary in the fourth quarter of 2022 was $56,368 per year. By that standard, the median earner should have a little more than $169,000 saved for retirement.
But not all of that should be invested in the stock market.
The Rule of 100
Investors typically allocate more money to higher-risk stocks when they’re young and have time to recover from losses, then gradually shift a greater percentage to safer bonds as they age to avoid selling in a down market.
One of the most widely followed rules says to subtract your age from 100 to find the percentage you should hold in stocks.
According to the rule of 100, 40-year-olds should allocate 60% of their savings to equity investments. That means the median earner would keep $101,400 of their $169,000 nest egg in stocks at age 40, with the rest held in safer and more liquid bonds and cash.
It Would Be Nice If There Were a Rule for All, but There Isn’t
Because people are living longer and spending more years in retirement, many financial advisors have changed the rule of 100 to 110, which would allocate 70% of a 40-year-old’s nest egg to stocks. That would put $118,300 of the median earner’s $169,000 nest egg in the market instead of $101,400.
Experts with the Motley Fool suggest allocating an even higher percentage to stocks until at least age 50 since 50-year-olds still have more than a decade until retirement to ride out any market volatility.
So, who’s right? Well, that depends on who the advisor is advising.
Does the 40-year-old have children? Are those children planning to attend college or have they already graduated? Does the investor own a home or rent? Is he or she divorced or caring for aging parents? Is there significant debt or an especially high or low income?
Those are just a handful of questions that a professional advisor will ask before settling on a percentage that suits the individual client’s goals, retirement timeline, risk tolerance and life circumstances.
“Variables such as health, job stability and family responsibilities play a significant role in shaping one’s investment capacity,” said finance specialist Josh Michaels, CEO and founder of Money4Loans. “The right investment amount by age 40 is not a one-size-fits-all figure. It should be a balance struck between aggressive saving, risk tolerance and life goals, with a focus on diversification to navigate uncertainties.”
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This article originally appeared on GOBankingRates.com: How Much Money Should You Have in the Stock Market by Age 40?