Are you looking to learn how to better manage your 401(k) for retirement success? You're in the right place. At 34, I managed to grow my 401(k) to over $500,000 during my relatively short 13-year career working in finance. Today, my 401(k) is now worth over $1,000,000 after I rolled it over to an IRA.
My 401(k) is seen as gravy for when I reach 60 because I've been focused on building my taxable investment portfolios for passive investment income. If your passive investment income can cover your desired living expenses, you're golden.
Treat your 401(k) as a “nice to have” retirement vehicle you do not depend on. Treat Social Security the same way. If you do, you'll likely end up having a lot more in retirement than expected.
Early Retirement And Your 401(k)
Early retirement is fantastic. There's only one problem. Most early retirees no longer contribute to their 401k's unless they start a business. If you start a business, preferably an online one due to the global pandemic, you can begin contributing to a Solo 401k.
However, most people can't be bothered. If you can't contribute to a 401(k), then you also lose out on employer 401k matching and profit sharing. I just took a look at my final year's employer 401(k) profit sharing plus match and it came out to $27,000. There's much more to your job than just your salary!
My 401(k) now makes up a minority portion of my stock investments. The reason why Is because I've been focused on building up my taxable accounts. It is your taxable accounts that will generate enough passive income to live off if you retire early.
That said, I still believe the 401(k) is one of the most retirement vehicles we have today. It is one of the legs in the new three-legged stool for retirement. Here's how to better manage your 401(k) for retirement success.
How To Better Manage Your 401(k) For Retirement
To better manage your 401k, you must first understand the reality of the financial landscape.
With the way the government loves to spend our money, I wouldn't be surprised if the retirement age for distribution without penalty increases beyond 59.5. Alternatively, the government could impose a “distribution tax” to take more of our money.
After all, with a massive government budget deficit due to the global pandemic, taxes will be going up to pay for all the stimulus spending. That said, we can hope for the best by reducing our mutual fund expenses and creating different scenarios to better prepare for our future.
The best way to increasing our odds for retirement success is to run various 401K investment scenarios. To do so, sign up for Empower, the #1 free financial tool. I've used PC since 2012 to manage my finances and analyze my 401K for excessive fees.
I will run three investment scenarios (Conservative, Realistic, Blue Sky) using the free 401k investment analyzer by Empower.
Regardless of whether you are retired or not, I encourage everybody to perform at least these three scenarios and write down some notes.
Early retirees need to be extra diligent given we are more dependent on our investments to survive. If you have years to go before retirement, I suggest you pretend you are retired now so you can develop a fire to be all over your money!
Conservative 401(k) Portfolio Analysis Part 1
General Instructions: Once you have signed up for Empower and linked your 401k, go to the “Investing” tab on the top right and then choose “401k Fee Analyzer.” This is the page where we plan to do all the analysis to get an idea of how different assumptions make big differences.
Base Assumption: The 401k alone is not enough to provide for a comfortable retirement. A 401k needs to be coupled with Social Security and other after tax investments to give ourselves a chance for financial security. This is my new three-legged stool in retirement.
In this example, we will use an existing 401k balance of $405,000. I assume no contributions and no employer match or profit sharing forever. Portfolio growth assumption is 4% per year with 0% additional fees. 4% annual growth is conservative given the average return for the S&P500 since the 1950's until now is roughly 7%. The 2009-2010 economic downturn helped bring the average down.
I'll also share what I'd do under each scenario to better manage my 401k.
Conservative 401(k) Portfolio Analysis Part 2
The Good: Despite not contributing anything to the 401K, even a conservative assumption of 4% allows the 401K to grow by $754,920 to $1,160,000 by the time I'm 65. $1,160,000 is OK if I were to live abroad or in cheaper US locations, but it won't go far in San Francisco or New York City.
The Bad: In 30 years, things will be much more expensive thanks to inflation. Honda Civics that now cost $20,000 will probably cost closer to $40,000. I expect all prices to at least double in 30 years thanks to inflation.
Hence, the buying power of $1,160,000 is more like $580,000 in today's dollars after fees. Let's subtract another 20% income tax on $580,000 (spreading the distribution out), and I'm left with only $464,000. The figure is kind of depressing after starting off with $1,160,000.
Conclusion: Once you've built a decent sized nut, investment performance is the #1 criteria for portfolio growth and not contributions. The key is to build that nut. With ~$464,000 in buying power after taxes, fees and inflation, I could probably only live comfortably for 5-8 years in retirement before the money runs out.
As a result, I need to rely on the government's good graces, which is always a crap shoot. By now, I hope alarm bells are ringing in your head as to why it's so important to max out your 401K.
Realistic 401(k) Portfolio Scenario Part 1
Portfolio Assumptions: I assume $10,000 total annual 401K contributions (includes employer match) and a 1% higher 5% per annum investment return for 30 years. In my case, the contributions come from a self-employed 401k plan. If you are working, contributions will just come from your paycheck and employer.
Realistic 401(k) Portfolio Analysis Part 2
The Good: By just contributing $10,000 a year and performing 1% better, the total gross 401K figure after 30 years grows by $1,551,642 to $2,429,266, or more than double the conservative case scenario. Meanwhile, the percentage lost to fees goes from 17% down to 14% or two years of retirement lost compared to four years lost. $2.4 million should be enough for most people to live comfortably in retirement.
The Bad: I'm still paying $262,693 in fees based on my existing portfolio largely due to a Fidelity Blue Chip Growth Fund that has a 0.74% expense ratio vs. 0.35% or lower for similar Vanguard Funds. We should all run the mutual fund fee analyzer on our 401Ks and see where we can optimize.
Conclusion: A little effort goes a long way. When you combine multiple improvements to your portfolio (increased contribution, increased employer match, and 1% increase in annual growth), you end up with explosive long term results.
Let's cut the $2,429,266 in half due to inflation to account for today's dollars. We get $1,214,633. Take 20% tax and we're left with $971,706 in buying power.
I can live comfortably for the next 11-20 years just off my 401K. Unfortunately, I plan to live longer than age 72-80. This means the 401k is still not enough or I have to cut down on my lifestyle.
Blue Sky 401(k) Portfolio Scenario Part 1
Portfolio Assumptions: Let's contribute $17,000 a year, receive a $17,000 match/profit sharing from our employer, and earn a 7% annual return. Please note for 2021, the maximum contribution is $19,500, but goes up to $20,500 for 2022.
We aren't Warren Buffet. Therefore, 7% will have to do to account for large double digit returns and losses throughout the years. Remember, it's still better to be conservative in a Blue Sky scenario. You don't want to come up short in retirement.
Blue Sky 401(k) Portfolio Analysis Part 2
The Good: We don't have to financially worry in retirement anymore! By contributing $17,500 to the 401k, receiving a 100% employer match, and returning a reasonable 7% a year thanks to good research and good luck, our 401K has now grown by $4,821,749 to $6,844,000.
The Blue Sky scenario leads to an amount 2.5X greater than the base case scenario. Furthermore, we'll probably earn at least $30,000 a year in Social Security. Note that you can contribute up to $51,000 in your self employed 401K up to 25% of profits.
The Bad: $647,216 in fees is an incredible amount that equates to 10% of my entire 401K balance. Think what you can do with $647,216? I'm imagining a $147,000 Range Rover Super Charger with $500,000 left over to go on 10 world cruises! Even a half percent in fees really drags down returns over time.
Furthermore, we are assuming we'll have the desire to work until age 65. I thought I was going to work until 40, but got tired and wanted to pursue my online endeavors. Things are always changing.
Conclusion: Maxing out our 401K, working for a company until 65, and doing due diligence on our investments pays off big time. A lot of folks hop around firms. This results in a temporary stoppage of compounding and contributions since it takes a while for shares to vest.
If we can stick it out with a company long enough, while diligently saving by adjusting our lifestyles accordingly, there is no doubt we will become multi-millionaires by the time we are 65.
Inflation And Taxes Hurt 401(k) Returns
Take half of $6,844,000 for inflation and 30% off for taxes and you still get around $2,400,000 in today's dollars for retirement. With $2.4 million and no mortgage at 65, life is pretty good. However, if you want to be a real millionaire, thanks to inflation, you need to have a net worth of at last $3 million.
We can book first class tickets to Bali and stay in a waterfront bungalow for a month. Or, we can eat and drink until our heart's content. Another great idea is to pay for our children's education. More money means more options!
The best thing is that during all our years, the markets did most of the work and we probably didn't even notice the pre-tax savings pinch. This is how you better manage your 401(k) for retirement success!
Better Manage Your 401(k) By Being Consistent
To better manage your 401k to achieve financial you chould:
1) Take a proactive step in analyzing your portfolio. If you don't have any idea what you are investing in, how much in fees you are paying, and how much you have, it's hard to build wealth.
2) Run multiple scenarios based on different savings, matching, and investment returns. I only introduced three, but you can and should put in your own assumptions in the 401K Investment Analyzer section. We all have different 401K amounts, risk tolerances, and investing prowess.
3) Estimate the net present value of your retirement savings and account for taxes. Inflation is a real killer. Which is why you should consider investing in real assets that inflate over time. Real estate is my favorite asset class to build wealth. Even more so than stocks. I've personally invested $810,000 in real estate crowdfunding for more passive income and diversification.
4) Draw some conclusions after each scenario analysis. Conservative portfolio scenarios generally require extra after tax savings and/or alternative income streams to fund retirement. You don't want to end up short in retirement so it's best to keep your forecasts low.
5) Set realistic return goals and consider rebalancing when such goals are achieved. It's important to have discipline during extreme market swings. The average net worth for the above average person is higher due to aggressive 401(k) contributions.
I'll be the first to admit I love doing scenario analysis in practically everything I do. So should you when it comes to buying a car, getting a new job, choosing a school and more.
Stay On Top Of You 401(k)
To replicate the charts in this post with your own figures simply sign up for Empower. Then link your portfolio on the left hand side of the dashboard. Finally, click the Investing tab on the top right to see the results.
The process only takes a a minute to sign and is completely free. I recommend running your 401k and investment portfolios through the Retirement Fee Analyzer tool as well. The software found $1,700 in 401k fees I had no idea I was paying. Finally, you can easily track your net worth in one place automatically.
For even more powerful retirement planning tools, you should also check out NewRetirement. NewRetirement is specifically built to help plan for retirement. You can learn more about NewRetirement by reading my review.
Diversify Your Investments Into Real Estate
In addition to investing as much as possible in your 401(k) for as long as possible, also consider diversifying into real estate. You can buy your primary residence and you can also invest in private real estate funds for further diversification.
Fundrise runs private real estate funds that predominantly invests in the Sunbelt region where valuations are lower and yields are higher. Its focus is on residential and industrial commercial real estate to help investors diversify and earn passive returns.
Fundrise currently manages over $3.5 billion for over 500,000 investors. I've invested $954,000 in private real estate funds since 2016 to diversify my investments and make more money passively. After I had children, I no longer wanted to manage as many rental properties.
Another private real estate platform to consider is CrowdStreet. Crowdstreet is a marketplace that mainly sources individual commercial real estate deals from various sponsors around the country. This way, you have more customization to build your own select private real estate portfolio.
Make sure you diversify your portfolio and do your due diligence on all the sponsors. Look up their track record, their management, and whether they have had any blowups before. Although CrowdStreet screens the deals, you have to do your screening as well.
About the Author
Sam began investing his own money ever since he first opened a Charles Schwab brokerage account online in 1995. Sam loved investing so much that he decided to make a career out of investing. He spent the next 13 years after college on Wall Street. During this time, Sam received his MBA from UC Berkeley.
In 2012, Sam was able to retire at the age of 34 largely due to his passive income investments. Sam now spends his time playing tennis, spending time with family, and writing online. He hopes you will better manage your 401k as financial freedom rocks.
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