The road to becoming a millionaire is closer than you think.
With a tax-advantaged retirement account and the power of compounding interest, you can become a 401(k) millionaire.
Here’s what you need to know.
1. Start investing early
Your company’s 401(k) should not be viewed as an optional benefit. Rather, your 401k is an essential wealth-building tool that can make you a millionaire.
Due to the power of compounding interest, the earlier you start investing, the better.
For some, that may be easier said than done.
However, if you haven’t started investing though a 401(k), it’s never too late to start.
Don’t use your past mistake as an excuse not to participate in the future.
Let’s take a look at an example to see the power of compounding interest.
We can use the Make Lemonade investment calculator to see how much a 25-year-old will have in a 401(k) plan at retirement based on annual contributions and investment rate of return.
If a 25-year-old investor invests $4,600 annually for 40 years in a 401(k) at a 7% annual return, that investor would have approximately $1.02 million at age 65.
In comparison, if a 35-year-old investor invests $10,000 annually for 30 years in a 401(k) at a 7% annual return, that investor would have approximately $1.02 million at age 65.
If you are older than 35, have not invested in a 401(k) and plan to retire at age 65, then you will need to invest more each year to try to hit the $1 million goal.
2. Contribute the maximum amount to your 401(k) annually
Pay yourself first.
Every dollar that you invest in your 401(k) is an investment in your future.
Each year, make sure to contribute the maximum amount to your 401(k).
Currently, you can contribute $18,000 per year to a 401(k).
In addition to your regular income, you can use bonuses and raises to help meet the 401(k) annual limit.
If you are 50 years-old or older, you can contribute $6,000 additional per year.
If you are not contributing the maximum amount each year, you should increase your contributions to reach your retirement goal of becoming a millionaire by the time you retire.
3. Take advantage of your employer match
If you work for an employer that offers a 401(k) employee match, this is a financial benefit that you cannot miss.
An employer match is free money.
What if you think you can’t contribute to your 401(k) because you have too many life expenses?
Answer: your expenses are too high.
Invest in your retirement first, then set your spending based on what you have left.
You also don’t have to choose between saving for retirement and paying off debt like a mortgage or student loan.
Always make your required monthly debt payment, and contribute at least enough to your 401(k) to receive an employer match.
Apply any remaining funds to whichever is higher – your interest rate (pay down debt) or expected investment return (fund retirement).
4. Read the fine print
When you choose your 401(k) investments, don’t just throw darts at the board.
Read the fine print of each fund that is offered through your 401(k).
All funds are not created equally.
At a minimum, compare fund performance, management fees and expense ratio.
Index funds tend to have lower fees than actively-managed funds.
5. Leverage the power of compounding
The power of compounding is a powerful force that can propel you to 401(k) riches.
Here is an extreme example to show you how the power of compounding can help propel your portfolio.
What would you rather have:
- A penny that doubles in value every day for 30 days
- $5 million
Without blinking, most of us would choose $5 million.
However, you would rather have a penny that doubles in value every day for 30 days. Why?
After 30 days, your penny would have grown to $10.7 million.
Your portfolio won’t grow 100% each day for 30 periods, but this example demonstrates the positive impact that compounding can have on your retirement.
Final Thoughts: The Naysayers
Some people say that becoming a 401(k) millionaire is impossible or is a poor investment vehicle. Why?
“You can earn a higher return on other investments.”
“You won’t be with the same employer for 40 years.”
“You can’t access your money for 40 years.”
“Many employers do not offer an employer match.”
“It’s very hard to contribute the maximum amount to your 401(k) each year.”
All of these statements could be true based on your personal circumstances.
Besides a 401(k), there are plenty of other ways – and perhaps better ways – to become a millionaire, too.
For example, you can start a successful business or invest in venture capital deals.
Remember: a 401(k) is one way to become a millionaire. It’s not necessarily the only way, a guaranteed way or the best way.
However, these factors can increase your chance to become a 401(k) millionaire:
- Investment Amount: the more capital you invest, the more potential for growth (in a rising market environment)
- Time Horizon: the longer your time period, the more opportunity for growth
- Investment Return: the higher your investment return, the faster you can achieve meaningful wealth
Zack Friedman is a keynote speaker and Founder & CEO of Make Lemonade, a personal finance comparison site that helps you save money and live a better financial life.