Investing in a 401k

This is the safest way to make money. It’s safer than bonds, safer than stocks and far safer than speculating in options or futures.

If you invested only in this vehicle, you would be better off than 90% of your neighbors, co-workers and poker buddies. Personally, I swear by it. It is one of the best ways to safely grow wealthy — no matter what happens to the stock market. Consider this…

Since the beginning of the year, the S&P 500 is up 5.6%. That’s not bad. But you could be sitting on gains of at least five times that large. And you would have had to assume 33% less risk.

This “magic” investment vehicle I am talking about is none other than your boring, ignored and misunderstood 401(k) account.

Roll your eyes if you wish. But hear me out…

Investing in a 401k: Lots of Free Money… With Very Little Downside

Recently, I was at a Maryland Terps football game with three friends. All are in their mid- to late 20s. All have solid jobs. And all are smart guys. But one of them, Randy, has never contributed to his 401(k) plan. Never! While drinking a few beers in the parking lot, we tried to explain to Randy why he is the biggest moron ever. I went first…

“Look, Randy, over the course of the year, the funds I have invested in for my 401(k) are up only 1.9%. That sounds puny considering the market is up about 5%. But because of the matching system my employer has, my real returns are above 30%.”

My buddy Tom jumped in. (Truth be told, he was on his 7th or 8th beer at this point.) “Yeah, Randy, you are an idiot. You are giving away free money — and lots of it. You dumb ass! Wait, aren’t you trying to have a kid soon? Lord help us all…”

As the only sober one in the group, I jumped back in the mix…

“My 401(k) gives me a chance to take some calculated risks with very little downside. For instance, I can invest in emerging markets, metals and smaller-capitalization stocks and never have to worry. Thanks to my employer’s matching system, it would take a massive downturn in the markets for me to lose any money. And more than likely, I am going to make quite a bit — even if the market stumbles a bit, like it did earlier this year.”

Investing in a 401k:Stability in a Volatile Marketplace

Of course, the secret to properly investing in your 401(k) is to make regular contributions and to invest the maximum you can in order to receive the largest “match” from your employer. For instance…

Lets say your employer matches 50% of up to 6% of your salary. Just to make things simple, let’s say your monthly salary is $1,000.

If you invest 6% of that, you are putting $60 a month into your 401(k). On top of that, your employer matches 50% of that. So they contribute another $30 to your account. The net result is that you are immediately up 50%. Or another way to look at it, the funds you are invested in would have to fall by 33% before you would be in danger of losing a penny in what is otherwise a volatile marketplace.

Not a bad deal. And while this may be considered a mainstream idea (not something you normally see here in Sleuth), I would argue it is still an important one. While as many as 75% of all Americans do contribute to their 401(k) plans, the most obvious group of people missing are the 20- and 30-somethings.

David Wray, president of the Profit Sharing/401(k) Council of America says, “If a person saves for 10 years, between the ages of 25-35, and stops, but keeps that money invested, they will have as much money when they’re 65 as a person who starts saving when they’re 35 and saves religiously for the next 30 years.”

Of course, David is right. The earlier you start investing, the more money you’ll have when you need it — thanks to the power of compounded interest. To show you how powerful this phenomenon is, I ran some numbers for you.

Investing in a 401k:Different 401k Investing Scenarios

Person A (we’ll call him Tom) invests $1,000 every year from the time he is 20 until he is 60. Assuming a 20% return (factoring in the employee contribution and the market’s returns), Tom will be sitting on $1.17 million. And that’s assuming he never contributes more than $1,000 a year.

Person B (we’ll call him Randy) doesn’t start investing until he is 30. But when he does start contributing, he puts $1,500 — 50% more than Tom — in every year until he is 60. But when he goes to retire, Randy has only $320,608 in his bank account.

That my friends, is the power of compounded interest. And that is the power of a good 401(k) plan. The earlier you can get started, the better your future will be.

Now I realize money is tight with a lot of young people. But there are always ways to make sure you have a few dollars to save. Whether its cutting back on those coffees from Starbucks, packing your lunch instead of eating out or renting a movie instead of going to the $13 theater show, you can find ways to come up with a little cash to store away.

If you have kids, grandkids, friends or relatives who are in their 20s, do them a favor: Send this Sleuth to them. Let them think about what they are missing out on.

Investing in a 401k:Seeds of Wealth

Also, if you have very small kids or grandkids, they too can benefit from the miracle of compounded interest. One of my colleagues, Justin Ford, wrote a brilliant book called Seeds of Wealth. It is all about saving just $1 a day for your kids so they have a substantial nest egg by the time they are young adults.

According to Justin, “Even if your children average just over $1 a day in savings through the preteen years and a little more than $2 a day through the age of 21, they can still end up with anywhere from $335,854 (at a 13.2% return) to $855,279 (at a 18.8% return) a generation from now.”

Imagine what an incredible gift it would be to make sure your children are financially well off!

At the end of the day, investing in a 401(k) and saving a dollar a day when you are a child isn’t the kind of radical advice that most people want to hear about these days. But those who wish to retire wealthy will pay attention.

Here’s to your own wealth,

James Boric
The Sleuth

P.S.: Maryland won the football game 24-10. And my buddy Randy did decide to start investing in his 401(k). It was a good day all around.

The Daily Reckoning