In business you often come across something called “best practices”. Basically a best practice is a technique or a method that has shown over time to be the best way to achieve a stated goal.
We can do the same thing in our personal lives by taking an area where we would like to improve and study what successful people have done. For example, if you want a better marriage, find an older couple that have been together for 50 years and talk to them about how they stayed together for so long.
Fidelity investments is the largest manager of 401k plans in the US. As a result they have amassed a huge amount of data about the habits of 401K investors. Last year they published a study of individuals who had amassed a balance of more than a million dollars in their 401K and had an income of under $150,000. These are people who had accumulated a very large balance and had done so despite not having an enormous income.
In the study they identified 5 traits that were common across these 401k millionaires. If we want to be successful too, it would be wise to consider the “best practices” followed by these 401K millionaires.
1. Start saving early
The first key to building a million dollars in your 401k is to start early. Time is your friend when it comes to investing. You can still build wealth if you start later in life, but it is much harder. If you start right away at the beginning of your working career, it really isn’t that difficult to build up a substantial sum of money over a 40 year working career.
When we are in our 20’s though thinking about retirement is often the last thing on our minds. Shortly after I started my first job, I had an older co-worker call me over to his office one day. He showed me examples of how even investing a relatively small amount starting in my early 20’s could turn in to hundreds of thousands of dollars over the course of my life. I had already started putting some money in the 401k we had at that company, but I really appreciated the encouragement he gave me.
2. Contribute a minimum of 10% to 15%
It stands to reason that if you are going to build wealth, you have to be saving. You can’t put $20 in here or there and hope to have millions of dollars. Dave Ramsey recommends saving 15% of your income for retirement. Brian Preston of the Money Guy show recommends 20% if possible. Fidelity’s data indicates that these 401k millionaires they studied averaged 10-15%. One of the real benefits I see in workplace retirement accounts is the money comes out of your pay before you even see it. If you had to write a check for 15% of your income, many people would find that pretty difficult. But when it comes out before you ever see it, it is much easier to save.
This is also why it is so important that you get out of debt and stay out of debt. When you are swimming in payments as many folks are, it is very difficult to have anything left over to save. Second, this is why it is important to have a spending plan. If you don’t have a plan for your money, I guarantee you’ll get to the end of the month and wonder where it went. To be able to save consistently, it has to be a part of your plan.
Saving 10 to 15% over a lifetime is not easy. It takes discipline and intentionality.
3. Meet your employer match
If your 401k has an employer match, make sure you are saving at least enough to get that full match. For example my employer matches 50 cents on the dollar up to the first 6% I contribute. So for every dollar I put in up to 6% of my wages, they’ll throw in another $.50. That’s amounts to a 50% return on my investment before I ever even get started. It is free money! Don’t miss out on it.
Think of it this way. Suppose you were called into a meeting at work. At the end of the meeting, your boss said, “Oh, by the way, when you walk out of the meeting you’ll see a table outside the door. There are stacks of twenty-dollar bills on it. Feel free to help yourself to a stack as you leave.” How many of us would say, “Nah, that’s ok. I don’t really need it.” Not very many. And yet in essence that is what we do when we don’t take advantage of an employer match.
The last thing I will say is if you work for an employer that does not match funds you save, don’t lose heart. It is a nice little boost to your savings if they do, but if they don’t it doesn’t mean that you can’t still save a very healthy little nest egg over the course of your working life.
4. Consider mutual funds that invest in stocks
The first key to saving is you have to do it. The second is you need to be saving in the right things.
The temptation is to put your savings into conservative options that are unlikely to lose money. You worked hard for that money and you don’t want to lose it. I understand that. But, you also have to understand that while you are unlikely to lose money, you are also unlikely to make much money. The amount of money you make is directly tied to the risk you take. The real problem is you still need to account for income and taxes. If you aren’t earning at least 5-6%, you are really losing money when it comes to actual buying power.
But what if the market goes down? What if we have another year like 2008? I guarantee it will. There will be many years where your investments lose money over the course of your lifetime. But there will also be years where you make money. A couple of years ago I had a year where my 401k was up over 30%. Can you expect that every year? Of course not. 30% is not a typical year but then neither are awful years like 2008. I believe history has shown there will be many more years where you will make money than you will lose money and so over all if you look at a 40 year working career having money invested in stocks will serve you very well.
One final note before moving onto the last item. Many 401k’s have the option of investing in your own company’s stock. They might even provide incentives for you to do so. Generally, speaking investing in your own company’s stock is a very risky thing to do. The problem is what if something terrible happened and your company went out of business? You now have lost your job and your life savings. That’s just too much risk to be that dependent on one company no matter how great your company is.
5. Don’t cash out when changing jobs
We know that the years of spending a 30 year career with one company and then retiring with a gold watch and a fat pension are pretty well over. Statistics show that most of you will work for many different companies and perhaps even work in completely different fields over the course of your working lifetime. The question is what do you do with that old retirement account when you leave your company?
Let’s consider young Bob. Bob gets a job right out of college and spends 3 years working for Big Corp, then he gets a better job offer from another company. Bob, being the bright guy that he is, has managed to save $10,000 in his old 401k. At this point Bob has a couple of options. He could roll this over to an IRA that he controls and continue to let it grow, or he could cash it out.
If he decides to cash it out, first he’ll have to pay taxes on the money and second since he is not 59 1/2 he’ll get hit with a 10% penalty for an early withdrawal. By law his 401k provider will withhold 20% for taxes. So when Bob cashes it out, after taxes and penalties he’ll only get $7,000. Still that’s tempting. After all, $7,000 would make a really nice down payment on that new sports car he has had his eye on.
Now let’s consider if Bob instead rolled it over to an IRA. Just for the sake of argument we’ll say it was invested not particularly well and only made about 6% (in reality over time the market has averaged almost twice that.) And finally we’ll say Bob never added another dime to it. He just left it alone for the next 40 years until he reached retirement at age 65. Bob would now have $102,857.18 in that account! And that was just assuming he had invested rather poorly and never added anything to it.
So on the one hand Bob had a down payment for a sports car that rusted out in a junk yard many years ago and on the other hand Bob could have a six figure account to boost his retirement. Not hard to see which decision is the wise choice.
A couple final notes
Two last things I want to say. First you may be saying well that’s great if I was 20 and just starting out but I’m 50 and heading into the home stretch and I haven’t saved anything. Am I doomed? No, of course not. It may not be possible to be a 401k millionaire. But you can still start saving today. For many people, their 50’s are their highest earning decade. Start saving today. You can’t change your past, but you can change your future. You might need to work a little longer. You may not amass millions. But if you start today you’ll be far better off in retirement than you would be had you done nothing.
Lastly, if you are younger, am I saying if you follow these steps you are guaranteed to be a millionaire. No. There are no guarantees in life. I do believe strongly though that following these five 401k “best practices” will serve you very well. And what if we are half wrong? You’d still be entering retirement with over $500,000!
If you are reading this and you are in your 20’s think carefully about these five steps. I know retirement may be the last thing on your mind, but a few small wise choices today will make a huge difference in your life down the road. And if you are older but have a young person in your life, share this article with them. Just like that older co-worker that pulled me aside many years ago, you might just change someone’s destiny.