Every year, thousands of new graduates receive their
degrees from colleges and universities across the United States and
enter the workforce. When you get your first job, you might be inclined
to focus on salary and advancement opportunities and ignore that
“boring” stuff about your new employer’s 401(k) plan. Hey, wake up! Pay
attention! That’s your future.
It’s widely known that most young people don’t think about saving for
the future. It’s not because they have faith in the Social Security
system. If anything, the young people graduating these days take it on
faith that Social Security won’t be there for them. The real challenge is that in one’s early twenties, 65 is just too far down the road to be worth the bother.
And it’s not like there’s nothing else to do with the money. When
you’re just starting out in your own place, you need to put things to
put in it. And you need a car. And you need food. And you need money
for drinks at the club every Friday… and Saturday… and maybe a few
other days…
Wait a minute. What if I told you that you were practically guaranteed
to be a millionaire if you would start saving by age 25? It’s true!
Thanks to the magic of compound interest, relatively little investment
today can mean enormous wealth in the future. And even if you can’t
completely max-out your 401(k) today – for 2006, that would mean
contributing $15,000 over the course of the year – there are some
strategies you can follow to make sure that you put something away. (A
quick note here. If you work for the Government, I'm talking about the
Thrift Savings Plan [TSP]; for those of you employed by non-profit
organizations, you may have a 403[b] plan.)
Three strategies to save
Regardless of which tax-deferred savings ("defined contribution") plan you have, here are three ideas that will help you:
1. Start right away. Ideally, you’d sign up for a 401(k) payroll
contribution your first day on the job. Why? Simple: no one likes
saving, because they feel like they’re losing money they’d rather
spend. If your first paycheck already has it coming out, though, it’s
just one deduction on a pay stub that already has half a dozen or more other deductions listed. You won’t even know how much you’re missing.
2. Take all of the free money. Many employers offer a “matching”
contribution of some sort, typically either a dollar-for-dollar or a
50% match, in which you’ll be credited extra money based on what you
contribute up to a certain value. In other words, if your company
offers a 50% match on contributions up to 6% of your pay, if you
contribute 6%, they’ll pay another 3% for a total contribution of 9%.
That can add up fast, and it means that even if your investments don’t
perform well, you’re already gotten a 50% return just for contributing!
3. Increase your savings each year. Everyone likes to get a
raise. Raises mean more money in your pocket – and if you’re smart,
they’re also opportunities to increase your 401(k) savings. When you
get a raise, just like when you start a new job, you don’t know what
your net increase would be anyway. So, if you get a 3% raise, boost
your 401(k) contribution by 1.5%. You’ll still see an increase on your
paycheck, and you won’t miss the difference.
One strategy to invest
The other side of the 401(k) equation is how to invest the money. This
is one situation where you want to follow your natural instinct: after
you get it set up, ignore it. Setting it up is pretty easy, too, thanks
to mutual funds.
A mutual fund invests in a number (hundreds, and sometimes thousands)
of different entities, so it’s already more diverse than you could make
it on your own. Choose a no-load (read: no fee) fund that tracks the
market. Every now and then, a fund manager gets lucky, but in general,
the market outperforms individual stock picks. (Occasionally, a fund
will offer a fund that self-adjusts its mix based on your expected
retirement date. If one of these is available, it’s your best bet. Even
if not, though, nearly all 401(k) plans offer a market track fund of
some sort.)
Have your account set up to put as much of your contribution as
possible towards your selected investment each month. 401(k) plans
sometimes require up to 2% of the account value to be held in a money
market account, basically a cash account to cover fees from buying and
selling your mutual fund shares. That’s fine, but make sure that the
minimum is held in cash.
Nothing else to do but wait.
So, you’ve set up your 401(k), and contributions are coming out.
They’re being automatically invested in a no-load market track fund.
What’s next? Just keep increasing your contribution each year, and
always start a new job saving at or above the level of your last job.
When you turn 50, ask a financial planner how you might want to shift
some of your money into bonds or income-generating investments. But for
the next few decades, you can just relax.
You’re going to be a millionaire. Congratulations.
