How to Maximize Your 401(k) Account
When and how you invest your money during the wealth accumulation years makes a huge difference on your ultimate retirement wealth. In fact, often a retirement account’s value due to annual contributions is dwarfed by the value of the compounding annualized investment returns. Also, taking a moderate amount of investment risk over a long time period can make a dramatic difference in building retirement wealth. To maximize your 401(k), there are certain strategies to follow.
JP Morgan demonstrates this in the graphic below, showing four hypothetical employees with different retirement savings strategies: Consistent Chloe, Quitter Quincy, Nervous Noah and Late Lyla. Please note that this hypothetical doesn’t take into account the timing of variable investment returns, which can materially affect these results. This illustration also assumes that the retirement money is not needed to pay bills over the course of 30-years (life does happen, and it can get in the way of building retirement wealth). This illustration is simply meant to showcase the power of investment compounding and higher investment rates.
Source: JP Morgan Guide to Retirement, 2018 page 16.
- Consistent Chloe: Chloe invests $5,000 annually ($200,000 over her career) consistently for her entire career at a 6.0% rate of return. When she retires, her portfolio is projected to be $820,238 – 76% of which came from compounding investment returns and 24% contributions. This is the clearest way to maximize a 401(k) account.
- Nervous Noah: Noah invests $5,000 annually ($200,000 over his career) but doesn’t trust the capital markets, so he invests it very conservatively in cash, earning a low 2% return. While he put in the same amount in contributions as Chloe, Noah’s balance at 65 is only $308,050 – 62% less!
- Quitter Quincy: Quincy starts out on the right track but stops contributing to his retirement when he is 35 years old and only contributes $50,000 to retirement over his entire career. Because he started early and is invested at a 6% rate, he ends up with a projected $401,230.
- Late Lyla: Lyla starts saving for retirement when she is 35, ten years after Quitter Quincy. She ends up contributing $150,000 over her career span. Interestingly, she ends up with about the same amount of savings as Quitter Quincy, ($419,008 vs. $401,230) despite contributing 3X as much money to her account ($150,000 vs. $50,000).
The point I am making here is that making contributions to your retirement as early as possible leverages the power of investment compounding to maximize your 401(k). In fact, if you are like Consistent Chloe, over 76% of your wealth come from the investment returns in the account after the annual contributions have been made. In this case, Consistent Chloe doesn’t contribute that much more than her work colleagues, she just contributes consistently over the course of her career. Quitter Quincy contributes the least (by far) of the group … and still does OK, just because he started early. Finally, Nervous Noah did not do himself any favors by adopting a conservative long-term investment strategy, as he does not get the full benefit of compounding returns with a low investment rate, despite making annual contributions as much (or greater) than everyone else.
