If you are young and wondering what is the surest way to become a millionaire, I can tell you right now that it is to max out your 401(k) every year. This is the simplest and most assured way to build wealth. The problem is you have to start young and most of us don’t know that when we’re starting out. Unfortunately, we spend too much money and don’t save and invest enough in our 20s. Even I didn’t want to contribute to my 401(k) when I started working 20 years ago. To a young guy who just started working, retirement is 40+ years away. Why should I put so much money aside? Fortunately, my dad convinced me to just start contributing to my 401(k) and saved me from one of the biggest mistakes a young person could make. The compounding effect of investing early is absolutely amazing. It’s too bad so many working people don’t understand the concept and miss out on this incredible wealth building tool.
The unfortunate truth is that about half of all US households have no retirement savings at all. Even households that saved for retirement usually haven’t saved enough. According to the latest (2013) Survey of Consumer Finance, a typical household near retirement age only has $14,500 in their retirement account. The half with no savings at all brings down the median quite a bit. If we just look at the households with retirement assets, they have about $104,000 saved. That’s still woefully inadequate and most retirees will have to depend on other sources of income such as Social Security Benefits, pensions, and part-time work.
Luckily, I’m not average and you aren’t either. I have been maxing out my 401(k) for many years now and our retirement accounts are in a much better shape than the chart above. Let me show you how much wealth you’d have if you maxed out your 401(k) contribution every year since you started working. Hold on tight because you will be amazed by the power of compounding.
Maxed out 401(k) every year
The graph below shows how much your 401(k) would be worth if you maxed out your contribution every year.
Note: In our scenario, I have our worker contribute the max contribution divided by 12 on the first of every month. To make it simple, we’ll invest in VFINX, the Vanguard S&P 500 index fund. I used VFINX’s price on 12/17/16 to figure out the 401(k) value (green line below.)
Here is how to read this graph.
- The horizontal axis is how many years you have been working.
- The green line is how much your 401(k) would be worth if you maxed out every year.
- The blue line is how much you have contributed.
If you started working in 2006, then that’s 10 years you could have maxed out your 401k. If you contributed the max every year, then you’d have almost $300,000 in your 401(k) account by now.
I’ve been working since mid 1996 so that’s about 20 years. If I maxed out every year and invested in VFINX, then I should have around … $600,000 in my 401(k) at the end of 2016. My account is a bit short, though. I didn’t max out my 401(k) contribution when I first started working. It took me a few years to increase my contribution to the maximum allowed. Also, I have some bond funds in my 401(k) and these don’t perform as well as the S&P 500 index. Currently, I have 537,000 in my 401(k) and that’s closer to 18 years of max contributions.
*I update this post every December with new data.
How is your 401(k) doing?
The full table is below. It’s very easy to use. You just need to look at the first column and find the number of years you’ve worked. The Accumulated Value column shows how much your 401(k) would be worth if you’ve maxed out your contribution right from the beginning. The 4th column shows the total contributions over the years.
*I put this table on Google Spreadsheet. You can click on this link to see it. Unfortunately, the formula did not carry over from Excel. Let me know if you see any mistake.
You can clearly see the magic of compounding on this table. If you contributed $7,313 in 1988, it would have turned into $109,136 today! ($1,294,964 – $1,185,828.) Wow, that’s simply amazing, a 1500% increase. Time is your best ally when it comes to long term investing.
It’s clear that by maxing out your 401(k), you will become wealthy by the time you retire. If you started working before 1992, you would be a 401(k) millionaire by now. I love my 401(k) and I can’t wait for it to hit 7 figures someday.
In addition, I didn’t even add any company matching to this chart. With company matching, your 401(k) balance should be quite a bit higher than my table here. Now that I mention company matching, I wonder why my total isn’t higher. I guess the first few years were really crucial and I didn’t max out those years. Also, I worked less than half a year in 1996 so I didn’t contribute much in that first year. At that time, I didn’t know you could max out your 401(k) contribution even if you only worked less than half a year. If I could go back, I would definitely carve out $9,500 and put it in my 401(k). If you’re young, you should try your best to max out your 401(k). That’s the best time to invest.
Oh, I remember now. I was chasing performance in the early years and kept moving my investments around. That’s a bad way to invest because funds that perform really well one year, usually can’t repeat it. In the retirement account, it’s better to invest consistently in a low cost index fund.
Max out your 401(k)
Of course, every 401(k) plan is different. Your retirement plan might not have very good investments or your fees might take a big bite out of your total return. If you don’t know how much fees you are paying then you should signup with Personal Capital and try their 401(k) fee analyzer tool. This free tool will help you figure out how much you’re paying. For example, we’ll pay about $38,000 in fees by the time I’m 55. That sounds like a lot, but it is actually very low at 0.15%. Anyway, if you’re paying too much fees, you probably should move your investment over to funds with lower fees.
For most people, maxing out your 401k contribution every year is the easiest way to become a millionaire. You will pay less tax and you won’t leave any employer matching on the table. The contribution is auto deducted so you don’t even miss the money. Start investing when you’re young and the magic of compound interest will supercharge your 401(k) and help ensure a comfortable retirement.
How is your 401(k) compared to my table? Are you ahead or behind?
If you need help keeping track of your finances, try using Personal Capital to manage your portfolio. They have many great tools for investors including the 401k Fee Analyzer and the best retirement calculators on the internet.
Retirement savings by age graph – National Institute on Retirement Security