A little effort and a lot of patience can go a surprisingly long way in building a great retirement nest egg.
Considering that the average 401(k) balance for people over 65 is around $270,000 (according to Vanguard), we conclude that there aren’t that many 401(k) accounts worth more than $1 million. is safe. In fact, the average is weighed down by many people with far smaller retirement accounts.
But there are certainly some seven-figure 401(k) accounts out there, some of which are owned by ordinary salaried workers. Fidelity, a retirement plan administrator and fund company, reports that about 2 percent of the 23 million participants in workplace retirement plans have balances of $1 million or more.
So what did a few do and many didn’t? Here are four things the typical 401(k) millionaire knew or should have done when building a nest egg.
1. Make the most of your free money
Most employers that offer 401(k) plans also match additional funds to a portion of employee contributions. Granted, it’s usually not a huge amount. Employer contributions are typically capped at 6% of an employee’s wages, but the average employer contribution last year was just 4.8% of a worker’s wages, Fidelity reports.
Still, for most workers, that can amount to several thousand dollars a year.
Image source: Getty Images.
Pitfall: Most employers will only contribute as much as you can. If your company offers a 100% match on the first 6% of your wages that you contribute, and you put only 3% of your wages into your 401(k), your company also offers only 3%. will be contributed. If you don’t put your own money into your 401(k) account, your company won’t either.
So, quite simply, you should always aim to contribute enough to get the maximum matching funds your employer offers. It is discretionary money and should not be left on the table.
Obviously, you do not need to make only the minimum contribution required to ensure your company’s maximum contribution to your retirement savings account. Even if your contributions don’t match, you can invest for the long term and reduce your taxable income while working. So, assuming you like your plan options, you should contribute more if possible.
2. Your plan’s best-performing fund option may be the simplest
Your 401(k) plan will likely be managed by a mutual fund company, and your investment options are often limited to that company’s proprietary funds. That’s fine. These are likely cost effective for the administrator and therefore cost effective for you.
However, just because a fund is available within a 401(k) plan doesn’t necessarily mean it’s the best option for you. In fact, it may be most beneficial to stick with the fund company’s less interesting products: index funds that track the performance of familiar benchmarks like the S&P 500 or the Nasdaq Composite.
Believe it or not, most actively managed mutual funds that aim to beat the market end up underperforming the market. Over the past five calendar years, nearly 79% of large-cap mutual funds available to U.S. investors have underperformed the S&P 500, according to data regularly collected by Standard & Poor’s. Over the past 10 years, 87% of them underperformed the S&P 500. Investment trusts underperformed the index.
One possible exception to this statistic is plan administrator funds. However, this is unlikely. The strategy with the highest chance of success and lowest risk is probably to invest in mutual funds designed to match the performance of the overall market.
3. Don’t settle for default options
Although not common, some employers, and even some states, automatically enroll their employees in a 401(k) retirement plan if the company offers one. It is mandatory. Employees don’t even have to fill out any paperwork. If an employee does not actively choose to opt out or choose their own investment options, the employer can simply auto-enroll the employee using the default contribution and investment options.
But it’s your future financial health that depends on it, so it’s better to take an active role and choose your investment options. Fill out the necessary paperwork and choose to deposit the appropriate percentage of your wages into your retirement account. Again, make sure you have enough to qualify for dollar-for-dollar matching funds that your employer contributes on your behalf. That should be your minimum starting point.
But perhaps the real sticking point in most 401(k) plan default options is the funds you end up owning. These are likely to be target-date funds, featuring portfolios that become more conservative as you approach retirement age. While this is a well-intentioned approach to the problem of managing asset allocation risk, it is a one-size-fits-all solution and may not actually be the best one for you. It is usually better to select assignments manually. This may require some paperwork as well.
4. It’s only a matter of time
Last but not least, while most 401(k) millionaires may have wisely decided on their choices, most of them believe that their great I would still admit that it wasn’t an act. Time and the power of compound growth played a large part. Investors only provided seed money.
The graph below illustrates this idea by plotting the growth of a portfolio built on a $7,000 annual investment in an S&P 500 index fund that yields a 10% annualized return. Over 30 years, this hypothetical individual would contribute $210,000 worth of principal to the account. However, each year’s increase in value can generate its own increases in subsequent years, so your overall profits will snowball. The final result? The nest egg is worth just over $1 million at the end of the 30-year period, most of which reflects the return on invested funds.
Data source: Calculator.net. Graph by author. For hypothetical and illustrative purposes only. You may get different results.
This hypothetical example is not a completely accurate representation of what you can expect from your 401(k). What is not reflected here is market volatility. The average return for the S&P 500 is about 10% per year, but results in individual years vary widely. In some years, market values can increase by more than 20%. In other years, you lose your position.
However, the important point is still the same, and it’s clear from looking at the graph. 401(k) Most millionaires go through a period when their retirement accounts start to get very large. More than half of their net profits are earned in the last third of the investment period, with growth from previous profits being a significantly larger factor than new capital contributions. The key is to stick to your plan for the first two-thirds of your career and continue contributing steadily, even when progress feels slow.
