If I had to choose one financial topic for all my late-20s, early-thirties clients, friends and family to learn, it would just be the plain old 401k . Forget the fancy stock tips from your brother-in-law, ignore the expensive whole life your neighbor is trying to sell you, resist the urge to put all your income into your home, and just consistently fund your 401k. The following is a great reminder of the power that simple strategy.
By Anne Tergesen (Marketwatch.com)
What does it take to become a 401(k) millionaire?
- image source: Shutterstock
Given the stock market crash of 2008 and Americans’ ultra-low savings rate, the very notion of amassing a seven-figure retirement-account balance may sound unlikely — if not impossible.
But while rare, 401(k) millionaires aren’t purely theoretical creatures. Among the 12 million people with 401(k) accounts managed by Fidelity Investments, for example, about 50,000, or 0.4%, have balances of seven figures or more.
Not all of them are Mitt Romney (or his colleagues), either. In fact, of the 5,500 millionaires Fidelity studied closely, 1,000 – or about 18% – earn less than $150,000 annually.
What do these guys know that the rest of us don’t? Not much, it turns out. According to Fidelity, the advantage today’s 401(k) millionaires have is mainly behavioral. “They have the discipline and commitment to save” early and often, says Jeanne Thompson, vice president of market insights at Fidelity.
Specifically, Thomson found that the current 401(k) millionaires:
- Started saving early and therefore had accumulated $426,000, on average, by 2000. (Their current average balance: $1.2 million.)
- Saved 14% of their annual pay, on average, not including their company match.
- Took full advantage of company contributions that averaged 4.8%, by saving up to their employer’s match and receiving profit-sharing contributions.
“They are like ironmen,” says Thompson. “They are committed and disciplined about saving and are in it for the long haul.”
The 401(k) millionaires also sidestepped two pitfalls that plague a significant number of investors. They’ve held a relatively high percentage of their assets in equities – with an average equity allocation of 88% at age 45 and of 54% at age 70. Stocks tend to earn higher returns than bonds and cash over time and so make it easier to build wealth. Thomson notes that, despite that historical tendency, “some young people shy away from equities.”
Moreover, she adds, the millionaires kept their hands out of the cookie jar. These days, 44% of those under age 30 who change jobs cash out their 401(k) accounts, a move that requires them to pay income taxes on the entire distribution—and, often, start their retirement savings over from scratch, says Thompson.
Given that today’s crop of 401(k) millionaires benefited from the long bull market that stretched from 1982 to 2000, how likely is their experience to repeat? Fidelity calculates that someone who earns $40,000 a year and starts saving at age 25 will have $1 million by age 67, assuming he or she receives 1.5% annual raises, saves 16% a year, and earns a 7% annual return. If returns average 5.5%, he or she would need to instead save 22% a year—a sum that includes the employer match.