Sometimes even people who, like us, write about investments on a regular basis, forget to go back to the basics. With so much constant chatter about markets, quantitative easing, tapering, derivatives, etc. on the business news channels, it can be easy to get caught up in the day to day events. Now, those can be very important to one’s portfolio and should be covered, but it’s also a good idea to take a step back now and then and remember the simple truths.
Many people are offered a 401K at work and yet do not participate, or barely participate. This has got to be the biggest mistake in the entire world of investing, in no small part because it is so easy to correct. It is understandable, of course, that many people feel that they need every last dime of their paycheck just to pay the bills and get by. And it is easy to put some opportunities out of your mind when faced with a tight budget. Additionally, there may be some people that really, truly, honest to goodness, simply cannot afford even a few dollars to be taken out of their paycheck. But for most people the math is so overwhelmingly in favor of contributing to their 401K that it really is a must.
Let’s use a simple (and simplified) example of a single tax filer making $40,000 a year. I chose this fictional person for the easy math, of course, but I also wanted to use someone who makes less than that which could be considered wealthy in any way. Now let’s say that her company offers a 401K with a 50% match up to 6%. (This is a fairly common offer at many corporations–although many are better). It simply means that the company will contribute half of the money you did into the 401K on the first 6% of your salary.
So in our example, let’s say that the employee decided to contribute 6% exactly into her 401K. 6% times $40,000 equals $2,400. At the end of the year, the company will match you at 50% pay you $1,200 and deposit it into your 401K.
But it doesn’t end there. The 401K contributions are considered pre tax by the government. Since the person in our example is in the 25% bracket that means that she really only contributed $1,800 in out of pocket money. So, for the cost of about $70 a paycheck (assuming that she is on a bi-weekly cycle) our fictional worker ended up with $3,600 at the end of the year. Total return on her investment? 100%! That’s right, double your money. Now, there are caveats like the government wanting their taxes that you avoided… someday. But for the most part, the math is fantastic no matter how you slice it. Furthermore, contributing even more than the 6% yields the tax savings and that alone is an excellent deal for most people in most circumstances.
If you have been wanting to start saving for the future, look no further than your companies’ 401K. March into your HR department (or ask a friend), get the instructions to sign up and get to it. It probably won’t take more than10 or 15 minutes and you will be an investor. Of course, you may want to take your time with choosing the investment options in the 401K, but that’s a conversation for another day. The point is that it is very easy to sign up, and that’s even more important than which funds you eventually settle on. There are lot’s of great investment ideas and financial planning suggestions and insurance thoughts floating around, but no other investment idea offers you free money to invest. Plus, look at it another way: it’s not free, but part of the compensation your company offers you to work there…and you’re saying, “no thanks, you pay me enough as it is“. From either angle it looks like a good idea to make sure you sign up for your 401K.