Start a 401(k) early and max it out every year
Starting a 401(k) Early would have to begin as soon as possible, like with your first job out of college. You have to sign up for the 401(k) plan immediately and plan to make the biggest contribution possible. For 2020, that's $19,500 per year. It can become substantially more if your employer offers a matching contribution.
You'd also have to plan to invest your entire account in equities. That could give you an annual rate of return of about 10%. That's been the average return on the S&P 500 going all the way back to 1928.
So let's say you graduate from college at age 22 and sign up for the company 401(k) plan immediately. You max out your 401(k) contribution at $19,500. With an employer matching contribution of 3% to 5%, you could easily hit the $1 million mark by age 40, with a 100% allocation in an S&P 500 index fund. We recommend using Blooom to max out your 401 (or reading this guide)
If need be, supplement that with an IRA — even if it's not tax deductible — or a Roth IRA.
What if you're self-employed?
You certainly won't have an employer-sponsored retirement plan, but does that mean you can't have a plan at all?
If you're self-employed, there are two retirement plans you can set up for your business. Each can enable you to save even more money than you can through an employer-sponsored 401(k).
The first is a Solo 401(k). This is a 401(k), but it's one that works specifically for a single participant. (However, a spouse can be included.) The “employee” contribution limit is the same as it is for an employer plan, maxing out at $19,500 for 2020.
But since you're both the employee and the employer under the plan, you can also make an “employer” contribution. That can be up to 25% of your income. The full limit, including both the employee ($19,500) and employer (up to 25% of income) contributions, is $57,000. That could create a quick path to a million dollars.
The other option is the SEP IRA. You can contribute up to 25% of your self-employment income to the plan. (It sometimes can work out to be less than 25%, due to the convoluted way it's calculated, but it's still a generous contribution amount.) For example, if you earn $100,000 from your business, you can contribute $20,000 per year.
In most cases, the solo 401(k) is likely to result in higher contributions. But with either plan, you can also add an IRA to the mix, increasing your total retirement contributions. Consider doing that even if it isn't tax-deductible.
Invest a high percentage of your income
If you're a young adult and you seriously want to make $1 million before turning 40, you're going to have to make a real commitment to getting control of your finances.
We're talking about saving money here — a lot of it. What's a lot? Financial planners often recommend saving between 10% and 15% of your income toward retirement. But we're not talking about retirement here; we're talking about becoming a millionaire 25 years earlier. That's going to require a commitment to savings that will border on painful.
So, we're not talking about 10% or 15%, but more like 30%, 40% or even 50%. If your average income between the ages of 22 and 40 is $75,000 and you're able to save 40%, that comes to $30,000 per year.
Now, if you're saving money and investing through regular taxable accounts, you won't have the advantage of tax deferral that comes with retirement plans. In that case, you might have an average annual rate of return of, say, 7%, versus 10% with a tax-sheltered portfolio invested 100% in an S&P 500 index fund. (The remaining 3% would go to pay income taxes at the federal and state levels.)
But even so, $30,000 invested each year beginning at age 22, with an average return of 7%, will get you to the $1 million mark by age 40. Or actually about $1.2 million, to be more precise.
And of course, since the money will be sitting in taxable investments, you can begin withdrawing it when you turn 40, rather than having to wait until age 59½.
The question is how comfortable are you with the prospect of spending 18 years living well beneath your means?
Just keep in mind the payoff of being a millionaire very early in life. You can use a personal finance tracker like Empower to find out if you're reaching your goals.
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Further reading: How to Invest Money Wisely
Build a business
Building a business is certainly not easy. But it's also one of the most effective paths to making $1 million.
One of the reasons this is true is you're quite literally building something from nothing. For example, you may start a business with just a few hundred or a few thousand dollars. It's easier to do in the internet age than ever before. You can take advantage of the web to start a blog or create a website where you sell a product or service.
In the case of a website, you may not even need inventory or staff. You can purchase the inventory as you get sales or sub-out the service work to contractors. I have a friend who subs-out the work of an online trash business. He's become a millionaire already, so it is doable.
In the case of blogs, there is a number that has sold for more than $1 million. Most blogs are primarily hobbies to the owners, but there are some that are full-fledged businesses. They build up a large amount of steady web traffic, and that produces substantial advertising revenue. A very successful blog can easily sell for seven figures if the numbers are right.
But just about any business can be sold for a large windfall. Typically, the buyer of a business is looking to purchase the company's cash flow primarily. The sale price will be a multiple of that cash flow, maybe something like twice gross revenues. If the business generates at least $500,000 in annual sales, it could sell for $1 million or more.
Secondary benefits of building a business
Of course, if you start a business that generates that type of revenue, you'll also be able to save a lot of money along the way, particularly in retirement accounts.
This is why building a business is one of the most reliable ways to make a million dollars before turning 40. You can build up a substantial retirement portfolio while you're running the business, then collect a big windfall on the sale.
But building a business has another significant advantage. It's sometimes possible to build substantial cash flow in just a few years. This means if you launch your journey toward $1 million when you're 30, 32 or even 35, you may still make a million dollars before turning 40.
Building a business isn't as time-sensitive as building an investment portfolio. Because you can literally go from zero to seven-figure cash flow in just a few years, this could also be the quickest route to millionaire status.
Buy real estate
Real estate is one of the most time-honored ways to become wealthy. But it's also one of the riskiest. That's mainly because making big money in real estate involves using a lot of leverage.
Leverage is a double-edged sword. On the one hand, it enables you to control a large asset with a relatively small investment. If that investment pays off, the gains on your invested capital can be dramatic. But if the investment goes in the wrong direction, your relatively small investment can evaporate quickly. What's more, just because you lose your capital investment doesn't mean you're off the hook. You'll still be obligated on any loans still outstanding.
But since we're talking about how to make a million dollars before turning 40, let's ignore the risk side of the sword.
The “secret sauce” with real estate investing is leverage. You can buy a $200,000 house with a 5% down payment. That means you can have ownership of a $200,000 asset with just $10,000.
Now one built-in limitation to that strategy is that you won't be able to buy an investment property with small down payments. Lenders typically require at least a 20% down payment. It may be difficult to acquire a sufficient amount of real estate to become a millionaire if you have to come up with that kind of money for each property.
Making a million dollars in real estate with just $10,000 per year
Let's say that each year you purchase a new house for owner occupancy. For simplicity sake, let's say each property is purchased for $200,000. Since you'll be an occupant, you can make a $10,000 down payment. You'll live in the property for one year, to satisfy the lender requirement for owner occupancy.
You repeat the process each year for ten years, beginning at age 25. Your annual investment is $10,000. By the time you're 35, you own ten properties worth a total of $2 million. Each year, when you buy another property, you rent out the previous home to a tenant. The rental income covers the carrying costs of the home.
But let's also say that between the purchase of your first home and the time you turn 40, the value of your portfolio of real estate has increased to over $3 million.
Even after accounting for the mortgages on each property — which will also be significantly paid down as the years pass — you'll be worth well over a million dollars before turning 40. And your total investment in the ten properties will be just $100,000.
That's the power of leverage and how it drives real estate riches.
Shoot the works on high-risk stocks
Years ago I worked in a CPA firm and did tax work for an individual who was not a millionaire. This man was a factory worker and knew little about building wealth. But he had an opportunity — with a group of other individuals — to invest money in an upstart company.
There might have been 20 individuals who invested in this company, each contributing $10,000. When it looked like the business was going to fail, most of the others bailed out. But this client didn't. In fact, he sunk another $10,000 into the business.
Within five years, the company went public. When they did, this client's $20,000 investment exploded to $2.5 million.
Now there's no denying this was a lucky shot. But here's the thing: New business ventures are being launched all the time. Most of them are desperate for capital, even small amounts. Most will probably never pan out.
But it's a numbers game. If you're able to invest few thousand dollars in 10 or more upstart businesses, you'd need only one or two of them to take off, and you could become a millionaire within a few years.
Some people do this regularly. It's the basic idea behind the show, “Shark Tank.” They may become angel investors or invest in a stock of new companies or in the stocks of companies that have fallen on hard times, banking on a big turnaround.
It's certifiably a form of investment gambling. But if you have more than a bit of a gambler deep inside, investing in a portfolio of speculative businesses could be one of the fastest ways to riches.
Final thoughts on how to make $1 million before turning 40
Reaching the million-dollar mark by age 40 won't be easy. Statistically, there are only about 7.2 million millionaires in the US or about 5.8% of all households. And only 1% of the population make the cut before turning 40.
But if you're committed to being in that 1% who make it by age 40, be ready to commit time, effort — and lots and lots of money — to the process.
It's doable, but it's certainly not easy.