HOW MUCH TO CONTRIBUTE

HOW MUCH SHOULD YOU CONTRIBUTE TO YOUR 401K?

This question is a primary concern of most 401K investors.  This question creates anxiety in most 401K investors. 

You are probably unsure about the answer. 

We are not going to be able to provide you with the full answer today, but we want to start you down the path to answering this question and to becoming confident that you will have enough money to retire comfortably.

Like most of these questions, the answer is “it depends”.  The answer is specific to each individual and it depends on a variety of factors:

• The age at which you started contributing to your 401K.

• Your current age and account balance.

• Your investment strategy.

• Your expected income needs in retirement.

• Your expected increase in your income in your working years.

At the risk of oversimplification, today we are going to use simple examples to illustrate the two most important factors – the age at which you started contributing to your 401K account and your investment strategy.  We help our customers with these calculations for the specifics of their individual situation. 

If you start your 401K account in your twenties, you won’t need to contribute as much from each paycheck compared to starting in your forties.  The compound effect of investments is more powerful when your money has more time to grow.  Today, we will compare someone who started their 401K account at age 30 to someone who started at age 40.

The average 401K investor only generates annual investment returns of 5%.  But most people in our audience pay more attention to their 401K and use some version of a Target Date fund based on the Asset Allocation model recommended by the investment industry.  We will assume, therefore, that most people are generating investment returns of about 6.5% per year - still not very good but better than average.

We also used 3% for the company match amount.  This is the average company contribution percentage.

Our objective in this exercise was to replace current income in retirement.  The assumption is that Social Security will cover the impact of inflation in the future.  Again, everyone’s situation is unique, but we wanted to use reasonable assumptions to illustrate the key points.

In the table below you will see that someone that starts contributing to their 401K at age 30 and uses a Target Date fund for their investment approach, needs to contribute about 7% of their income to their 401K each year to replace their income in retirement.  This is close to the 6% average contribution percent for 401K investors.  So, starting early only requires a modest contribution.

The person who waits until age 40 to open their 401K account needs to contribute much more to replace their income in retirement.  If they use the Asset Allocation approach (Target Date funds) like the 30-year-old, they will need to contribute 20% of their income to their 401K.  This is probably not doable for most people and clearly demonstrates the benefit of starting early with your 401K account.

Starting at age 40 or later will require a better investment strategy to reach your retirement goals.  In the table, we compare how much the 40-year-old will need to contribute if they utilize a more aggressive growth strategy for their investments. With a better investment strategy that generates higher returns, the 40-year-old can reach the same retirement income level by contributing 13% of their income versus the 20% needed for the Target Date fund approach.  The 13% figure is still a challenging contribution level, but it is more doable than 20%.

The 40-year-old can rescue their retirement by using our Market Signals investment system which would only require a 6% contribution to reach the same retirement income level.

If you start contributing to your 401K account after age 35, you absolutely need a better investment strategy to make up for lost ground.  An aggressive growth strategy helps all 401K investors, but it is very important for the people who start later.  Our Market Signals system is ideal for people who are running behind with their retirement accounts.

Happy Investing,

Phil

---

Disclaimers The Beyond Buy & Hold newsletter is published and provided for informational and entertainment purposes only. We are not advising, and will not advise you personally, concerning the nature, potential, value, or suitability of any particular security, portfolio of securities, transaction, investment strategy or other matter. Beyond Buy & Hold recommends you consult a licensed or registered professional before making any investment decision.

Investing in the financial products discussed in the Newsletter involves risk. Trading in such securities can result in immediate and substantial losses of the capital invested. Past performance is not necessarily indicative of future results. Actual results will vary widely given a variety of factors such as experience, skill, risk mitigation practices, and market dynamics.