401K... on auto pilot

Contributing to the 401K my company provides is one of the few financial decisions that I am proud of.

A traditional 401K is a type of retirement plan that allows you to save money from your paycheck pre-taxed. This is a huge advantage because the money is not taxed until it is withdrawn from the account, which can only be done without penalty* when you hit the age of 59 1/2. (*except in special circumstances). Meanwhile the money in your 401K has time to earn interest and dividends, compounding tax-deferred. Money in your 401K can be diversified in stocks, bonds, mutual funds or other assets, even real estate! Also, you have the immediate tax benefit of having a lower taxable income.

Besides the tax advantage that the 401K provides, the other huge benefit is employer matching. Contributing to a 401K that your employer is willing to match is one of the best financial decisions you can make, because getting a 100% return on your money is difficult to do! The stock market only averages a 10% return (in long term investments). Joshua Kennon, from Investing for Beginners, is the author one of my favorite financial sites. Investing for Beginners is a great resource for newbies to the financial world. He has an article regarding the 401K, and makes a very good point encouraging everyone, even those in high interest credit card debt, to enroll in their 401K. If you are paying 20% on credit card debt, and not enrolling in your 401K with a 100% return, you are losing money. Joshua Kennon's article is also a great read to learn more about the basics of a 401K.

My company offers 100% matching on the first 3% of my salary, and 50% matching on the next 2%. To take full advantage of the employer matching, I contribute 5% of my salary. My current salary is $43,958.16 .

Here is the breakdown of my monthly contribution:

3% that is matched 100%: $109.90
Corresponding free money: $109.90
2% that is matched 50%: $73.26
Corresponding free money: $36.63

Summary:

My monthly contributions: $183.16
My company's contributions: $146.53


Total monthly 401K contribution: $329.69

Total yearly 401K contribution: $3,956.28

Since I have 36 years until I am eligible to withdraw money at 59 1/2, and 42 years until the normal retirement age of 65, I am able to be risky with the placement of my funds. I have put 40% in high risk stocks, 50 % in low risk stocks, and 10% in bonds. The less time you have to invest, the more conservative you need to be with your investments. Which leads me to the main point of this post...

The biggest advice I can give anyone about enrolling in their 401K is DON'T WAIT. The time value of money is so important. Time value of money is "The idea that money available at the present time is worth more than the same amount in the future, due to its potential earning capacity," according to answer.com. You can either put a minimal amount of money away each month now... or play catch up the rest of your life.

I went to a financial seminar right before I graduated college, and one story the speaker told is burned into my brain. Its the story of Jack and Jill:

Jill invested (with the help of her company matching) $4,000 for the first seven years after she graduate, and after that, she quit contributing.

Jack waited 7 years, and invested (with the help of his company matching) $4,000 for the next 30 years.

Assuming a 10% return, Jill would end up with $728,408 dollars! Jack would end up with $594,301. This is a difference of $134,107! Imagine if Jill would have kept contributing.

Moreover, Jill contributed $28,000, while Jack contributed 120,000! Jack contributed 4 times as much money and ended up with over 100,000 less.

This is a simple illustration that does not take into account annual raises, etc. But the end result is so compelling.

And did anyone notice how the female was the smart one? Coincidence? I think not. :)

I understand how hard it is to imagine retirement when you are young, its hard to see the point of putting money away now. It seems more important to have that extra couple hundred dollars a month. But when you look at the difference it makes in the long run, investing in your 401K is a no-brainer.

I get excited when I use an online calculator to estimate how much money I will save for retirement. I will do both a conservative and liberal estimate.

In my conservative estimate I use only a "cost of living raise" which is estimated to be about 3%. I will assume an 8% return. I will use 65 as my retirement age.

Conservative Estimate Grand Total:

One million eight hundred and five thousand two hundred seventy nine dollars!!

(Seems cooler when you write it out)

$1,805,279.00

In my liberal estimate I use a 5% raise, and assume a 10% return. I will use 65 as my retirement age.

Liberal Estimate Grand Total:

THREE million nine hundred seventeen thousand five hundred twenty nine dollars!!

(Wowza)

$3,917,529.00

Note: Obviously I'm a assuming a little more than I state. I'm assuming I keep my current job, the policies don't change, that there is no salary cap, etc. Also keep in mind with inflation a million dollars then will not mean what a million dollars means today.

So if I am doing nothing else right.... at least I am contributing to my 401K. I spent enough time while planning my 401K that I can now sit back and watch my millions grow.... literally.