Thursday, June 4, 2009

401K Quick and Dirty Style

Hey I’ll give you .25 cents for every dollar you show me. You don’t even have to do anything. Just whip it out and show it to me and I will give you .25 cents. How many dollars would you show me? Probably a hell of a lot. That’s free money.

Well for those of you with a 9 to 5 job your corporate employer probably offers you matching. At my firm it’s .25 cents on the dollar up to 6% of my salary. So I take 6% because I’ve already made a 25% return for the year on my savings. If you think about the fact that over the long term the stock returns roughly 9% your employer is almost tripling that or more. Why would you not do that?

Let’s look at some math (Note that these numbers are rough but make the point):
I assume that you are 25 and have 30 years to retirement. If you put just $50 bucks a month in your investment account for your working career you have $235,000 at an average of 9% return. If you increase to 100 a month you have $472,000. What if you wait ‘til you are 35 and start investing 200 or twice as much as our 100 dollar example. You only end up with $369,000 at age 65. That’s because of compounding aka leaving your earnings in the account for long periods of time. It adds up and the longer your money is in there the larger it grows.

So everyone should be saving something even it’s just $50 dollars a month because if you wait like most people our age you have to save over TWICE as much for the same results. You don’t want to do that. Believe me your future self will thank you.
So ya back to free money. We saw what happened with a 9% return. What happens when a 25% return is added to that? Most companies contribute lump sum at the end of the year so my math here is going to be a little off, but free money is free money. First off in our $50 a month example your Company is paying you another $6,000 in cash, because you saved money for YOU. You make roughly $285,000 for your actual contribution of $18,000 dollars. Compare that to the above. You made an extra $60,000 with matching. If you start 10 years later you have to invest over TWICE as much for the same return. And remember if you invest $100 you make $570,000 at retirement for your actual contribution of $36,000. That’s sixteen times what you invested. Also since Company's cap the amount of your salary they match (generally between 4-6%) you can never make up for the free money regardless of how much you save.

So for those of you who work for a Company with 401K matching:
1) Talk to your HR representative about your 401K program
2) Find out how much of your salary the Company matches and invest that much
3) Laugh because you just got a raise for doing something you should be doing anyway (Hell you deserve to be paid more anyway)

For those of you who don’t work for a Company with a 401K or you Company doesn’t match:
1) Save $50 extra dollars a month (if you can do more awesome! And even 10 dollars is worth it) and put it into a Roth IRA (call charles schwab and say “I want to put XX dollars a month in an IRA and have it drafted from my checking account”)
2) Tell them you want to invest your Roth contributions in a retirement fund with a goal for retirement in 2049 (or whatever age you want to retire at)
3) Laugh because every dollar you save now is worth more than $2 ten years from now

This is a quick and dirty intro post to 401K matching. If you have questions or concerns, leave a comment or hit me through facebook.

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