How to Retire as a Millionaire with your 401k Plan and 7 Strategies to Achieve Growth of your 401k Plan

(January 28th, 2010)

The above title how to retire as a millionaire with your 401k plan may seem too catchy to you, but it is worth reading this article about how one ordinary man named Knute Iwaszko became famously known as the ‘401k millionaire.’ Author of the book ‘The 401k Millionaire – How I started with nothing and made a Million”, Knute was not a Wall street hedge fund manager making huge salary or CEO of Goldman Sachs, he saved for his retirement while earning a $60,000 a year salary and paying the costs to raise 5 kids.

So you ask, how did he do it? First, he started budgeting his finances and started saving in his early 20s. He learned how to deal with routine monthly expenses and minimize them by living within his means, as well as how to deal with unexpected expenses such as medical bills, home repairs, etc. He also started participating in his company sponsored 401k plan at a very early age. His journey to start saving began in the early 1980s when 401k plans became available. In fact, it was just 2 years after the IRS introduced the Revenue Act of 1978 that then became the Internal Revenue Code (IRC) Sec. 401(k). In the early 1980s, Knute started saving money away in his company sponsored 401k plan while he was in his early 40s. During the same time, he was stacking money away in to a traditional individual retirement account (IRA)

Upon leaving his employer at age 59, Knute had $800,000 in his 401k plan and about $200,000 in his IRA. And it’s been 5 years and Knute has not had to even touch his retirement savings, largely thanks to the success of his book titled "The 401(k) Millionaire: How I Started with Nothing and Made a Million - and You Can, Too." Having said this, saving up $1 million before you hit 65 years of age seems like a very challenging task for almost anybody, especially if you have to come up with all of that money from your own pocket (earnings). The key to achieving this is the power of compounding interest. As the old adage goes, “Do not work hard for money; make money work hard for you!” When you compound your interest, you take your original deposit (principal), earn interest on it and plough back the interest to the principal to form a higher deposit, which then also earns interest on interest, which is what the concept of compounding is all about. The longer you leave money in a compounding interest account, the more it grows exponentially.

Rule of Thumb: Want to find out how soon you will double your money? Use the rule of 72t. With this rule, you divide the current interest rate you are getting on your deposit and divide it from 72. For instance, if you are currently earning 8% on your deposit, then you will double your money in:

If we increase the 8% to 16%, then your money will double in half the time, approximately 4.5 years.

Financial advisors suggest the younger you are when you start doing this, the more years of compounding interest you will have and the more opportunity for your money to grow. Having said this, how exactly can you save up $1 million in your 401k plan before you turn 65 years of age?

Example

Let’s crunch some numbers and start with basic assumptions. Assume Sam currently earns 10% on his 401k investments and is in the 15% income tax bracket.

i) Sam is 25 years old and contributes $6,000 a year ($500 a month) for 40 years until he hits retirement. His principal balance at age 65 would be $3,188,390.00

ii) Sam is 35 years old and contributes $6,000 a year ($500 a month) for 30 years until he hits retirement. His principal balance at age 65 would be $1,139,663.00

iii) Sam is 45 years old and contributes $6,000 a year ($500 a month) for 20 years until he hits retirement. His principal balance at age 65 would be $382,848

iv) Sam is 55 years old and contributes $6,000 a year ($500 a month) for 10 years until he hits retirement. His principal balance at age 65 would be $103,276

As you can see, the older you get, the harder it is to save up for retirement as the number of compounding years is shortened. However, it’s never too late for anything. Older people such as an investor who is 55 years old could increase the amount of money they save each year, for instance increase the annual savings from $6,000 a year to $15,000 a year. If this is the case, here’s the impact on retirement savings:

v) Sam is 55 years old and contributes $15,000 a year for 10 years until he hits retirement. His principal balance at age 65 would be $258,190

Below we list some strategies to help you bring your 401k plan back on track and achieve faster growth to enrich your retirement objectives:

i) Start saving early in your life and maintain consistency in your savings. By doing so, you will be minimizing stock market risks as well as other economic & systemic risks. By starting early, you will earn more years of compounding interest and will have more time to recover if your portfolio takes a hit due to bear markets.

ii) Max out your 401k contributions and take advantage of employer matched contributions. On Research 401k Rollover, we always stress the importance of receiving matching employer contributions from your 401k plan. The aggregate totals for both employer and employee contributions to a qualified 401k plan must not exceed $46,000 for 2008 and $49,000 for 2009. You can personally contribute up to $16,500 in 2009 towards your 401k plan while the remaining amount can come from your employer as matching contribution. Think of employer matching contributions as an instant return on your money, if you get dollar for $1 of your contribution, you are gaining an instant 100% return on your money.

Fact: The average matching contribution from employers is 50 cents on every $1, up to 6% of your annual compensation. Check with your Human Resources department for specifics on your company's limits.

iii) Be eager to learn where your 401k money is being invested. Take time to learn your investment holdings, which ones are winners and which ones are losers. If you have a pair of winning stocks and losing stocks, minimize your losses by selling the losers at break even prices, while letting your winners run up higher. Also if you invest in mutual funds, be sure to pick established mutual funds with low fees, and avoid those funds that put all of their portfolios in one or handful companies. Iwaszko did not build his net worth to a million $ by chance, he carefully studed all his stock mutual funds and which ones were returning good percentages and which ones were underperforming. He cut the losers and also joined an investment club that taught him more advanced investing research skills.

iv) Look for the long term and understand it's not always worth it to be too Conservative - When you have a working time horizon of 10 years or more, you should develop a modest to more aggressive investment strategy in order to beat inflation and build up a high nest egg for your retirement. Iwaszko says he started doing this in his 40s and became very aggressive. Since then, he put all his money in stock funds and had a great run up in the bull market. However, please note that past results are not indicative of future performance, so it is best to do research. Iwaszko suggests people sit down and assess their investing & risk preferences, if a person has 30 years time horizon, then he/she is able to take more aggressive risks. However, if someone is set to retire in 5 years, then a more conservative investing approach should be taken.

v) Always strive to keep your money working for you - This is the purpose of compounding anyways. You risk losing the power of compounding interest if you take money out of your 401k account before you retire, thus it is essential to leave the money in the account. Using your 401k plan for your short term needs greatly fractures the power of compounding interest and long term growth of your 401k account.
Tip: If you are making contributions to a 401k plan or an IRA, make contributions in the beginning of the year as opposed to end of the year. The reason for this is, you will earn more interest this way.

vi) Work as long as you can - This concept is very simple, the more you work, the more income you will generate and the more you will be able to save. People who retire early greatly underestimate how much they will need to survive and maintain their standard of living, or they are unsure how long their savings will last.

vii) Diversify your 401k investments - It is important not to risk all your assets in one basket because while some industries in the world may be booming, others may be going bust. If you fall your investments in the bust category, you will lose money.