Want to be a millionaire? It’s simple and just requires two things: Time and consistency.
And money. So three things.
And a job.
So, four things. But that’s it, I swear.
With those four things, you too can become a 401(k) millionaire by retirement age, which varies but for the sake of making this math easy, let’s say age 60 (it’s actually 59.5, but I don’t want to math with half an age).
A 401(k) is an employer-sponsored retirement plan that comes with tax benefits. If that’s confusing, the main point to understand is that you get to contribute pre-tax money and watch the miracle of compounding interest. If you want to know more about 401(k)s, talk to a financial planner. In fact, for any deeper financial strategy, talk to a financial planner.
I’m not a financial planner. But this isn’t a column about financial planning; it’s about math.
To be fair, I’m not a math expert either, but I don’t need to be one to explain becoming a 401(k) millionaire – that’s the beauty of its simplicity.
So how does one become a 401(k) millionaire? If you were to receive no match from your employer you could become a 401(k) millionaire at age 60 by socking away $242 a month. It feels painful at first and might mean foregoing Coachella or not buying lattes every day, but soon you won’t notice the smaller paycheck and soon you’ll enjoy watching your net worth grow.
Most people, myself included, won’t start at 18 for lots of reasons, so let’s say you start at age 30. Why 30? It doesn’t matter; I’m just providing examples.
Starting at age 30, you would need to contribute around $670 a month to be a 401(k) millionaire by the time you are 60. If you waited to start until age 35, you’d have to contribute around ~$1,050 a month.
The longer you wait to start, the more you have to contribute monthly. Of course, we tend to make more money as we age, so if you’re 18 and reading this, don’t get freaked out by $1,050 a month – that’s for old people. Your monthly contribution is substantially less (I just told you that, stop freaking out already!)
If you do wait way too long, however, I truly understand. My father and everyone else with common sense told me for years to get started and I didn’t. I waited until I was in my 40s and am paying the price – literally.
But it’ll be worth it. How? Here’s the magic of compound interest. If you start at age 18, you’ll contribute approximately $122,000 in hard cash, meaning the other nearly $880,000 is just stock market gains. If you start at age 30, more than $750,000 is from the stock market.
That’s letting your money do a lot of work for you.
Now, I made a few assumptions. First, I assumed that your employer did not have a matching contribution. If they do and you don’t take advantage, you’re basically leaving money on the table.
Let’s say your employer contributes a 50% match to up to 6% of your salary, which is a common matching plan. That means if you make $80,000 a year and you embrace the full match, you’d get an extra $2,400 a year for free. Well, you get it for putting up with your boss – but it’s free otherwise (Editor’s Note: Matt loves his boss).
Another assumption I made is that you’re contributing monthly. This was for easy math, but chances are good that you’re contributing either twice a month or every other week. This changes things slightly in that your returns are slightly better because you’re getting a little extra time in the market.
My largest assumption is that you’re getting an 8% average annual return. If you don’t know, the S&P 500 is an index of the 500 largest publicly-traded companies in the United States. It’s a common gauge of the stock market and there are investments that aim to mirror its performance.
Investing in an S&P 500 index fund or ETF is a straightforward and reasonable strategy if you don’t have a better one. A financial planner might tell you to consider diversifying with bonds, international exposure and/or other such investments. Again, talk to a financial planner
Of course, there’s no way of knowing what your actual return would be since I can’t predict the future. But the S&P 500 has averaged around 10% since its inception in the 1950s – though it has been slightly higher over the past four decades – so my assumption is reasonably conservative.
It’s also nice to automate as best as possible, because you will stay consistent without making riskier decisions. This is not a get rich quick plan. It’s a get rich in a few decades plan.
There are some things to consider when managing your portfolio, like making age-appropriate risks and periodic rebalancing of your portfolio, but for the most part setting your investing on autopilot and forgetting it is a decent strategy.
Automating helps resist the temptation to buy high and sell low by doing what’s called dollar-cost averaging, which is basically the theory that you make consistent purchases that are sometimes high, sometimes low, but in the end even out.
Eventually you’ll need a plan for using the money in retirement effectively, without going broke, but, again, this is about becoming a 401(k) millionaire, not what to do when you get there. Again, talk to a professional.
So that’s it. Time, consistency, money and a job. Four things. You got this.
Matt Fleming, MBA, is Pacific Research Institute’s communications director and policy fellow.