401(k) plans can be great ways to save for retirement, and their biggest advantage is how much they let you save each year. The limit for 2020 contributions to 401(k) plans is $19,500 for those under 50 or $26,000 for those 50 or older.
If you’re fortunate and diligent enough to hit that number year in and year out throughout your career, you can end up with life-changing wealth by the time you retire.
In fact, someone who contributed the maximum for 30 years and invested it wisely would now have a nest egg of more than $1.75 million — enough to provide most people with ample and sustainable wealth throughout their golden years.
What it takes to be a super saver
In order to get to that $1.75 million number, someone who started saving 30 years ago at the age of 35 just had to follow a simple savings and investment strategy:
- Contribute the maximum allowed by law to your 401(k) account. That ranged from around $7,600 back in 1989 to $19,000 in 2019.
- Make catch-up contributions once you reached the permitted age of 50. That added between $3,000 and $6,000 more per year starting in 2004.
- Invest using an asset allocation strategy that evolved over time. For the first 10 years from age 35 to 45, invest 80% in an S&P 500 index fund and 20% in a fund tracking 10-year Treasury returns. Change that allocation to 70%/30% during the second 10 years from age 45 to 55, and then to 60%/40% from age 55 to 65.
- Rebalance your investment portfolio to reflect the appropriate age-based asset allocation at the beginning of each year.
Anyone who did that would’ve turned just under $500,000 in total contributions into three and a half times that figure — all thanks to returns from the financial markets.
Lessons learned along the way
Over that 30-year period, there were a lot of things the market taught investors. The 1990s were extremely kind to retirement savers, and the portfolio would’ve hit the $100,000 mark by 1995. Similarly, the size of the nest egg doubled between 2002 and 2007 and more than tripled from 2009 to 2019.
Yet you would’ve had to be willing to endure long periods of tough performance. In 2002, after three tough years, your retirement account balance would’ve been less than it was in 1999 — even though you would’ve contributed $32,000 extra into your 401(k) during that period. Similarly, the market meltdown in 2008 would’ve lopped $90,000 off the value of your 401(k) even after considering the $21,000 you contributed during that year.
One clear lesson is how important the last years of your career are to your retirement savings. 2019 was better than any other year, adding more than $350,000 to the value of your 401(k) account. Those investment returns had the same impact that 16 years’ worth of contributions from 2004 to 2019 had in pushing your account balance higher. That $350,000 figure is also higher than the value of the entire account back in 2003 — after 15 long, hard years of maxing out contributions.
Finally, using an asset allocation strategy can help smooth the ride. For instance, during 2008, big gains for Treasury bonds helped to ease the blow from the plunge in stocks. The same was true during the bear market of 2000 to 2002, and although bond allocations did hold back gains during big bull markets in stocks, it’s a price many investors would find worth paying in exchange for being able to sleep better at night.
Have a goal
Saving for retirement is important, and 401(k) plans can help you achieve even lofty financial goals for your golden years. Whether you aim to max out contributions over your entire career or simply want to take advantage of employer matching and other benefits of 401(k) plans, the result will be a more financially secure retirement at the end of your career.
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Source: The Motley Fool