You don’t have to be making a million to save a million. If you have a 401(k) or other workplace retirement savings plan, you may be able to save a million—even if you make less than $150,000. An important note: Not everyone needs a $1 million balance in their 401(k) when they retire, and some people may even need more to help meet their retirement income needs. As always, it is critical to develop a personalized retirement savings and spending plan based on your circumstances and risk tolerance.
Start saving early
Beyond the obvious fact that the longer you save, the more you’ll potentially accumulate; contributing steadily over 30 to 40 years is especially beneficial in a tax-advantaged workplace retirement savings plan. This is because your money has an opportunity to grow more through the favorable tax treatment. You pay taxes on withdrawals from your 401(k), along with any earnings, in retirement. In a Roth 401(k), while contributions are taxed when you make them, all earning and withdrawals are tax free in retirement.
Determine Your Level of Risk
The younger you are the more volatility you can probably take on given a longer investment time horizon. Historically, the stock market has fluctuated greatly, but has, over the long-term, continued on an upward trajectory. Therefore, the prevailing theory is that the more time you have, the less likely a down market is to have long-lasting effects, as you are more able to ride the upward trend. Some experts suggest that younger investors (those who are 15 or more years away from retirement) invest 100% in stock funds. It may be worth it if they could boost your returns but there’s no evidence that active management can do better than a simple portfolio of low cost index funds. In fact, the evidence is just the opposite with even managed-account provider Morningstar admitting that low cost was a bigger indicator of superior performance than their own mutual fund star rating. However, you must know your risk tolerance to make sure you’re not invested too aggressively, or else you could pull out of the market at the wrong time.
When you’re investing for the long-term, annual fees are a crucial consideration. A recent study showed that a median-income household with two wage-earners pays almost $155,000 in fees during their working lifetimes. A 2% management fee can easily take 33% of your money over 10-15 years. Ideally, you should invest in a fund with an annual expense ratio less than 1% – or at least less than 1.5%, which is the industry average. Also, be aware of funds that have a sales charge or front-end “load.” This can be more than 5% of your investment and is deducted from your contributions.
Consider Long-Term Performance
When you research individual funds, you are provided with a variety of performance histories. It’s best to exclude performance histories less than five years in duration – the reason being that you need to see whether the fund has beaten its benchmark index consistently. Also, look at how funds perform in down market years. Some funds are more defensive with risk managementthan others and aim to avoid huge losses, even when the rest of the market is tumbling. Though past performance is no guarantee of future results, these steps can help identify a fund that has a good investment model and management.
Diversify & Research Your Options
Many experts suggest that diversification is key to any successful investment strategy. Although most funds are intrinsically diversified, ensure that you are adequately diversified across a range of assets and industries. Choose a healthy balance of stocks and bonds, large and small cap funds, international investments, and – if you have the stomach for it – a small percentage in commodities. Diversifying your portfolio protects against short-term fluctuations, and can minimize the effect of down markets.
If your employer offers a match program, it’s in your best interests to bump up your contributions at least to this level. Simply put, this is free money. If you’re struggling to come up with funds to get to that point, there are a myriad of ways you can save extra money to make up the difference: clip coupons to save on groceries, adjust your thermostat to save on home energy, or scale back your cable TV package. These short-term sacrifices can help you invest in your 401k plan, which can yield huge returns over the long run. Saving $1 million for retirement might seem like a tall order, but many 401(k) participants have done it, and continue to achieve this goal without earning more than $150,000 per year. Even though you may not need to save that much to have a comfortable retirement, the lessons learned can help ensure that you meet your goal to become a 401(k) Millionaire.