How to save $1 million for retirement

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I want to start a Roth IRA account and build the balance to $1 million. How much do I have to invest to do that? --M.G., California

I admire your optimism. At a time when many, if not most, investors are fixated on market volatility and worried about losing their shirts should the market melt down in the not-too-distant future, you're thinking about saving and investing for the long-term.

But as much as I like your upbeat outlook, I think you also need to temper it with some realism. Ending up with a $1 million IRA, traditional or Roth, isn't a pipe dream. A General Accounting Office report released last year found that some 630,000 IRAs had balances greater than $1 million. But the GAO also found that 99% of IRAs had balances below the $1 million mark, with a median account balance of just $34,000.

And the IRAs that did have seven-figure balances weren't funded solely by yearly contributions. The balances included money inherited from other IRAs as well as money that had been rolled over from 401(k)s and defined-benefit plans. Indeed, the GAO notes that it would have required double-digit returns greater than the Standard & Poor's 500-index actually delivered to hit the $1 million mark from annual IRA contributions alone.

I think it's fair to say that this isn't a goal you should expect to reach quickly, especially considering that you are starting to fund an IRA at a time when some experts are predicting subpar returns. ETF guru Rick Ferri has forecast a 7% annual long-term return for stocks and roughly 4% for Treasury bonds, assuming 2% inflation.

If you make the current $5,500 IRA maximum contribution every year and earn a 6% return each year, it would take 42 years for your IRA balance to reach $1 million. You'd actually get there several years sooner, assuming you contribute the IRA maximum as it increases with inflation and also begin making catch-up contributions (an additional $1,000 a year currently) once you hit age 50. Either way, we're talking about a very long time.

But while your $1 million goal may be daunting, that doesn't mean it's not achievable, or that you shouldn't try. The key is to go about it the right way.

Your main focus should be on saving as much as you can. Assuming you have sufficient income and the discipline to save, there's no reason you should limit yourself to funding just an IRA. In fact, by expanding your savings effort to a workplace plan such as a 401(k), where annual contribution limits are a lot higher ($18,000 this year, plus a $6,000 catch-up for people 50 and up), you can build a bigger balance much more quickly, and roll that money into an IRA later on.

For example, if you fund both a 401(k) and an IRA to the current max not including catch-ups—i.e, invest $18,000 in a 401(k) plus $5,500 in an IRA for a total of $23,500 a year—you would have a $1 million combined balance in 22 years, assuming a 6% annual return. That's too ambitious a savings goal for most people. And even if you could manage it, you would also want to confirm you're eligible to fund both an IRA and a 401(k) without resorting to the "back-door" route to a Roth IRA, which you can check by going to Morningstar's IRA Calculator. But the idea is that you'll have a larger balance and increase your odds of getting to seven figures if you save more than the IRA contribution limit.

The way you invest your savings will also determine the eventual balance of your IRA. Clearly, higher returns will lead to a larger balance more quickly. For example, if you earn 8% a year instead of 6%, it will take you 35 years instead of 42 to achieve a $1 million balance investing $5,500 a year in an IRA, and 19 years instead of 22 if you invest a combined $23,500 a year in a 401(k) and IRA.

Related: An investing strategy for a $1 million retirement nest egg

But earning more on your savings isn't just a matter of dialing up a higher return. You've also got to take more risk, and that increases the volatility of your portfolio and raises the possibility that your balance could get hammered if the market nosedives. If you panic and sell during such a meltdown, you could very well end up with a lower return than you would have earned with a less aggressive strategy.

A better approach: go with a portfolio that will give you a shot at realistic gains but you'll also be comfortable sticking with during major market setbacks. You can create such a portfolio by completing a risk tolerance test. Vanguard offers an asset allocation-risk tolerance tool that will recommend a mix of stocks and bonds based on your answers to 11 questions designed to gauge the level of risk you're comfortable taking. The tool will also show you how the recommended portfolio, as well as others more conservative and more aggressive, performed in both good and bad markets, so you can decide which is the best fit for you.

Related: 2 ways to a more secure retirement

As for choosing investments for your portfolio, I recommend you focus mostly, if not exclusively, on broadly diversified low-cost index funds or ETFs, many of which charge just 0.20% of assets or less in annual expenses. The reason is simple. The less of your return you give up to fees, the more quickly your savings are likely to grow, and the more likely you'll reach your ambitious goal.

One final note: For whatever reason, you seem to have decided to do a Roth IRA. You should know, however, that a Roth isn't automatically a superior option just because qualified withdrawals are tax-free. Generally, a Roth is a better deal than a traditional IRA if you expect to be in the same or higher tax bracket when you withdraw your contributions and investment earnings in retirement. But if you think you'll face a lower marginal tax rate in retirement, you may be better off doing a traditional IRA. Given that it's difficult for most people to tell what tax rate they'll face many years in the future, it can make sense to hedge your bets by keeping some money in both Roth and traditional accounts.

The most important thing, though, is to save diligently and invest whatever you manage to save in a portfolio you'll be able to stick with whether the market is soaring or slumping. Do that, and you'll know you've taken your best shot at achieving a secure retirement, even if you fall short of your $1 million goal.

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