When it comes to guaranteed returns, there is a list of investments perhaps as numerous as your fingers. The most famous example is the 401(k) with an employer match. In order to charm you into investing some of your money in the company’s 401(k) account, most employers tend to put up a bit of their own money as an incentive. The return is immediate, guaranteed, and something that should be captured. The bottom line is – in almost all instances you should make sacrifices elsewhere in order to receive the full employer match.
It’s Not Rocket Surgery!
In Corporate America, you can divide many companies into one of two plans (although there are many other matching schemes):
- 100% match up to 4% of your contribution.
- 50% match up to 6% of your contribution.
Think about what that means. You invest your money in an account earmarked for you. In addition to the tax break (either now or in the future, plus capital gains free from tax) you also get to pry a few more dollars from your company’s coffers. If you make $100,000 and contribute 4% into the first type of plan, you get an instant $4,000. You would need an Enron-style loss in order to make that not worth it… even if you toss everything into a Money Market account from that point further you’re still getting a ridiculously high return on your money. There is the occasional debt with an interest rate which may be able to compete with 401(k) matches, but the vast majority are no match for the instant returns. Same concept for the second type of plan – your company would turn your $6,000 into $9,000 just for contributing. If only all investing was that easy!
The Biggest Mistake
The biggest mistake employees make is assuming they can make up for a dearth of early-career savings in their later years. While it is usually possible to dump more absolute dollars into the account annually in greater years (assuming you don’t butt up against the contribution limit) your problem at that point is time, not free cash. I’m sure everyone has seen this graph of the value of a dollar compounded annually at 10% interest for 50 years.
If you invest it at year 0 and hold it to year 50? It’s worth $117.39. That’s powerful. If you invest in the 30th year, you have to toss in $17.45 to get the same result. Do you think you’ll be making 18 times your 25-year old salary at 45? The point is… you’ll make more, but it will be harder to reach your savings goals.
Where’s the Value Add?
Maybe you’ve read a variation on this article before at other personal finance blogs and you’re wondering, “Where’s the value add? I can read this elsewhere!”. Glad you complained, but I promise I’m not mailing this one in and getting soft. Here’s a calculator so you can determine exactly how much worse off you are by starting late in investing. This can obviously be applied beyond 401(k)s, but mind your taxes… Also, note it’s a constant return. Now stop complaining and play with the calculator!
So there you have it. Proof that it’s a marathon not a sprint, and you should start as early as you can. Thanks, as always, to Political Calculations for the calculator script. Complain or comment in that little Disqus link below.
Thanks for the mention. This is such a huge opportunity that so many people miss out. The problem is a lot of people put off investing in their 401(k) because they’re stuck thinking in the short-term. They only see the $500 per month that is being taken out of their check. They don’t think about the extra $3,000 per year that they miss out on because it’s going into an investment account instead of their pocket.
Thanks for posting the article (and stopping by)!
Yeah, opportunity costs are the big one, but the funny thing is even the withdrawal penalties are less than the match. So in an absolute emergency (I;’m certainly not advocating tapping 401(k)s you’d still be ahead with the match.
What can we do though? Keep writing, I guess!
Thanks for posting something I could riff with!
I agree with you – I just find it funny because if you did do something dumb like pull it out early, you’d still be on top of the game after IRS penalties. It’s a no-brainier even if you don’t use your brain.
I guess all we can do is write about it until people give in, right?
The company where my wife works used to match 100% up to the first 6%. They reduced that to 50%. Still a great deal!
Yeah, still a good deal! Too bad they took away the massive match, but definitely still take advantage of that. A 50% return is hard to beat, especially when it’s guaranteed!
I get 100% up to 6% – just recently upped my contributions…I was leaving too much of my company’s money on the table!
I’m glad you upped your contribution. It is funny to note 401(k) participation rates. Even though they are higher when there is a company match, they still aren’t the 100% I would expect when there is free money for the taking. Thanks for stopping by!