The Million Dollar 401k – Who Wants to Be a Millionaire?
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The average salary in the United States is $56,000 before taxes. Federal taxes drop that number down another 20% (assuming you live in a no state income tax state). After housing-$12,000 rent, transportation $9,000, food $6,000, health care $4,000, and miscellaneous expenses $5-$10,000 there’s not much left for retirement savings. Add in the unforeseen event-job loss or sickness and most people never manage to save a million. Also, the lack of understanding of how to invest results in even the most steadfast investor losing a significant chunk of their nest egg to unscrupulous financial advisors that push high fee investment vehicles that underperform the market (and net the advisor handsome commissions and bonuses). Company sponsored 401k’s can be equally dangerous-my husband’s company’s is filled with primarily +1.2% fee active mutual fund options-their S&P 500 index fund charges. 0.77%! Highway robbery. Some savers decide to go it alone doing their own individual stock picking-if 80% of money manages can’t do this and beat the S&P 500 return over long periods of time-what hope does the average retail investor have? If you decide to go this route-make sure you’re diversified in several different companies and definitely make sure all of your savings isn’t tied up in your own company’s stock.
The road to the million dollar 401k is filled with hazards but there is a way. Follow a few simple rules mapped out by the knowledgeable folks at Vanguard, Burton Malkiel, Jack Bogle, and Warren Buffett.
- Set up your finances to maximize your savings-don’t enter into high interest debt (credit cards, buying a new car every five years).
- Make sure you get the education required to attain a fulfilling, and good paying job. Everyone doesn’t have to be a doctor, lawyer, or engineer-art, film, and poetry are worthy areas of study. The world needs artists-just don’t spend a quarter of a million dollars pursuing these paths (and have a minor in business or computer science so that you can support yourself while you follow your dream)
- Save as much of your income as possible in tax sheltered vehicles (401k, Traditional and Roth IRA’s) and max out contributions to the IRS limits
- Invest regularly-ideally every paycheck.
- Determine the appropriate asset allocation (mix of stocks and bonds) for your age and risk tolerance and invest in low cost stock and bond index funds (Total Market Index, S&P 500, Russell 2000, Nasdaq, Russel Midcap, US Bond Index, Total International Bond Index, Emerging Market Index, International Market Index, etc.).
- Rebalance periodically
- If your company’s 401k offerings are high fee save enough to get your employer’s match and set up separate IRA’s at a discount brokerage like Vanguard or Fidelity (consider rolling over what you have saved with your employer at the end of the year to an IRA to minimize fees over the long term)
- If you have the ability have a separate taxable account invest in index ETF’s to minimize the tax impact of capital gains and bond yields
- Buy and Hold-even when it seems the stock market will completely collapse do not sell. Over the long term the market always goes up-around 10% annually on average over a 30 year period. If the S&P 500 ever actually goes to zero trust me you will have much bigger problems on your hands-it is likely the end of the US as we know it.
- Reinvest dividends to maximize the benefit of compounding.
- Have enough cash savings to sustain you for six months and to invest in a down market. Remember-buy the dip or when the market is on sale
- When changing employers-never cash out your 401k. Roll it over into your new employer’s plan or set up an IRA with a discount brokerage.
- Never borrow from your 401k!
$5000 invested plus a $5000 employer match invested in the stock market over 30 years at an 8% rate of return is worth $1.2mln at retirement. Following the rules above you should be able to build a sizeable nest egg. Now who wants to be a millionaire? I certainly plan to be one.