New employees start with nothing in their retirement accounts. Reaching the popular goal of $1 million for their golden years seems daunting. But a select percentage reach that magic value every year. What are their secrets?
In 1978, the retirement landscape changed with the start of the 401(k) plan. After that, the number of companies offering pension plans decreased. Today, employees are responsible for their own retirement planning and saving.
Sadly, the average 401(k) balance by age 65 is just over $200,000. That’s not a lot. It’s nowhere near one million dollars.
People with little to no personal finance knowledge see this as an insurmountable challenge. However, others have managed to scale that Everest applying the best strategies for retirement saving. They start by focusing on the factors they can control.
Start Early
The age at which a person starts contributing to a retirement plan is entirely in their hands. Successful workers who save $1 million usually start early. As a result, they leverage the power of compounding over many years. It takes at least 30 years to build a $1 million retirement account. Some people may do it in a shorter time, but that doesn’t happen very often.
Workers with a long-term outlook start early, and let time work for them. For instance, using a retirement calculator, a 25-year-old employee who saves $5,000 annually or $416.67 monthly and assuming an 8% total return will reach about $1.35 million in their 401(k). However, starting the process just 10 years later at age 35 nets only $590,677 — a big difference. Even doubling the savings rate does not allow the person to catch up. The result of saving $10,000 annually from age 35 to 65 is $1.18 million. So start that 401(k) early.
Consistency Is Key
Consistent contributions over many years are essential to reach financial goals. Life throws many twists and turns, including financial challenges. When money is tight, a relatively easy source of cash is 401(k) contributions. The tradeoff of using the money to pay current bills versus saving for a future cash flow many years in the future seems logical. But stopping contributions and starting again later will negatively impact the time it takes to reach $1 million.
Similarly, volatile markets can cause poor short-term 401(k) contribution decisions, but market corrections and bear markets are common. The definition of a bear market is a 20% decline. It sounds like a lot, and it is, but John Bogle’s advice is worth following: “If you have trouble imagining a 20% loss in the stock market, you shouldn’t be in stocks.”
That said, market corrections and bear markets eventually end, although the timing is always uncertain. However, research and history show stock markets have more positive days and years than negative over long stretches. In fact, between 1928 and 2022, 94% of the 10-year periods were positive.
It makes sense to be consistent with contributions because time matters more than timing.
Make the Most of Matching Contributions
Matching contributions from an employer can significantly add to savings. It’s free money in the account, permitting some workers to double their savings. According to asset manager Fidelity, the average matching contribution was 4.8%.
The percentage is small, but it adds up over time. The average American salary in 2022 was about $63,795; thus, 4.8% equals $3,062. Assuming an employer contributes the same amount, the total is $6,124 saved for retirement in a 401(k) plan in one year.
Companies usually match on a graduated scale. For instance, they may contribute 100% of an employee’s savings up to 3%, followed by 50% for another 3%. So, if workers contribute 6%, they receive 4.5% from their employer.
The bottom line is a person should save the minimum required to obtain the company match. Otherwise, they’re leaving cash on the table. Significantly, as people’s salaries increase, the matching amount also increases.
Sticking with Stocks May Help Total Returns
A 401(k) plan typically offers multiple mutual funds to participants. Most 401(k) millionaires recognize stocks outperform bonds and cash over time and often weigh their portfolios to hold more equities.
Historical returns and backtesting indicate since the end of the Great Depression, stocks have returned more than bonds by roughly 4%. This period covers decades and includes multiple geopolitical conflicts, recessions, inflation, and other events.
However, bond funds also have a place in a retirement portfolio because they’ll perform better than stock funds for periods. Moreover, they’re usually less volatile, helping cushion losses during market downturns.
If picking mutual funds is too hard, asset managers often offer target date funds matching anticipated retirement dates. These funds change their asset allocation between stock, bonds, and cash as a person ages, reducing risk.
The Bottom Line
The experts agree and emphasize time matters the most. Mike Hunsberger, ChFC, CFP, CCFC, of Next Mission Financial Planning, told Dividend Power, “How much you’ll have in your 401(k) at retirement will be dictated by 3 factors. They are the return you achieve, the amount you invest, and the length of time you’re investing. Of the three, time really makes the magic happen.”
Becoming a 401(k) millionaire is a challenging task. However, the formula is simple: start early, save consistently, take the matching contributions, and invest in stock and bond funds without taking on too much risk close to retirement.
