Most young people express a desire becoming a millionaire. Amazingly, becoming a millionaire is a simple goal to attain over the course of one’s life — but the key is to start early.
In this article, Mr. Samans discusses the value of saving in a tax-advantaged 401(k) or equivalent plans, and some simple strategies for building and keeping wealth.
Becoming a millionaire is easy!
Every year, thousands of new graduates receive their degrees from colleges and universities across the United States and enter the workforce. When you get your first job, you might be inclined to focus on salary and advancement opportunities and ignore that “boring” stuff about your new employer’s 401(k) plan. Hey, wake up! Pay attention! That’s your future.
It’s widely known that most young people don’t think about saving for the future. It’s not because they have faith in the Social Security system. If anything, the young people graduating these days take it on faith that Social Security won’t be there for them. The real challenge is that in one’s early twenties, 65 is just too far down the road to be worth the bother.
And it’s not like there’s nothing else to do with the money. When you’re just starting out in your own place, you need to put things to put in it. And you need a car. And you need food. And you need money for drinks at the club every Friday… and Saturday… and maybe a few other days…
Wait a minute
What if I told you that you were practically guaranteed to be a millionaire if you would start saving by age 25? It’s true! Thanks to the magic of compound interest, relatively little investment today can mean enormous wealth in the future. And even if you can’t completely max-out your 401(k) today – for 2006, that would mean contributing $15,000 over the course of the year – there are some strategies you can follow to make sure that you put something away. (A quick note here. If you work for the Government, I’m talking about the Thrift Savings Plan [TSP]; for those of you employed by non-profit organizations, you may have a 403[b] plan.)
Three strategies to save
Regardless of which tax-deferred savings (“defined contribution”) plan you have, here are three ideas that will help you:
1. Start right away
Ideally, you’d sign up for a 401(k) payroll contribution your first day on the job. Why? Simple: no one likes saving because they feel like they’re losing money they’d rather spend. If your first paycheck already has it coming out, though, it’s just one deduction on a pay stub that already has half a dozen or more other deductions listed. You won’t even know how much you’re missing.
2. Take all of the free money
Many employers offer a “matching” contribution of some sort, typically either a dollar-for-dollar or a 50% match, in which you’ll be credited extra money based on what you contribute up to a certain value. In other words, if your company offers a 50% match on contributions up to 6% of your pay, if you contribute 6%, they’ll pay another 3% for a total contribution of 9%. That can add up fast, and it means that even if your investments don’t perform well, you’ve already gotten a 50% return just for contributing!
3. Increase your savings each year.
Everyone likes to get a raise. Raises mean more money in your pocket – and if you’re smart, they’re also opportunities to increase your 401(k) savings. When you get a raise, just like when you start a new job, you don’t know what your net increase would be anyway. So, if you get a 3% raise, boost your 401(k) contribution by 1.5%. You’ll still see an increase on your paycheck, and you won’t miss the difference.
4. One strategy to invest
The other side of the 401(k) equation is how to invest the money. This is one situation where you want to follow your natural instinct: after you get it set up, ignore it. Setting it up is pretty easy, too, thanks to mutual funds.
A mutual fund invests in a number (hundreds, and sometimes thousands) of different entities, so it’s already more diverse than you could make it on your own. Choose a no-load (read: no fee) fund that tracks the market. Every now and then, a fund manager gets lucky, but in general, the market outperforms individual stock picks. (Occasionally, a fund will offer a fund that self-adjusts its mix based on your expected retirement date. If one of these is available, it’s your best bet. Even if not, though, nearly all 401(k) plans offer a market track fund of some sort.)
Have your account set up to put as much of your contribution as possible towards your selected investment each month. 401(k) plans sometimes require up to 2% of the account value to be held in a money market account, basically a cash account to cover fees from buying and selling your mutual fund shares. That’s fine, but make sure that the minimum is held in cash.
Nothing else to do but wait
So, you’ve set up your 401(k), and contributions are coming out. They’re being automatically invested in a no-load market track fund. What’s next? Just keep increasing your contribution each year, and always start a new job saving at or above the level of your last job. When you turn 50, ask a financial planner how you might want to shift some of your money into bonds or income-generating investments. But for the next few decades, you can just relax.
You’re going to be a millionaire. Congratulations.