The most important ally an investor has is time. Simply put, the longer your investment time horizon, the more time you have to ride out market volatility and take advantage of compound earnings on your investments.
Take, for example, your 401(k) plan. Simply starting to contribute a few years earlier can significantly boost your savings and help you become a millionaire in retirement. But if you don't have the luxury of time, you can still get to $1 million in a compressed time frame by maxing out your contributions. Hereʻs how.
Time is on your side
The average American starts saving and investing for retirement at the age of 31, and only about 39% start in their 20s, recent surveys have revealed. Also, another study found that some 25% of plan participants don't invest enough to get the full company match. Just starting six years sooner than average, at age 25, and getting the full company match can make a huge difference.
Not all employers offer a match, but many do, and it is typically in the range of 2% to 6% of an employeeʻs annual salary. For this example, let's say the company offers a one-to-one match up to 4%. If you simply started contributing 4% at age 25 and got the full company match, you would have accumulated almost $1.1 million by age 65. Thatʻs based on a $35,000 starting salary, a 3% annual raise, and an 8% investment return.
To see what a difference a few years make, if you waited to start just five years later at age 30, now with a starting salary of about $40,000 -- you would have roughly $800,000 by age 65. In other words, those five years represented about a $300,000 difference.
What if you max it out?
Let's say that ship has sailed, and you didnʻt start contributing at age 25, or even 35, to your 401(k) plan, for whatever reason. Can you still get to $1 million? Yes, but it may take a maximum effort, as in contributing the maximum to your plan.
In 2022, the maximum you can contribute to your plan is $20,500 per year. That probably would not be feasible or necessary if you are in your 20s or 30s, but as you get older and earn more money, it might be possible as a way to play catch-up. And if you are 50 years of age or older, you can contribute an additional $6,500 per year.
For this hypothetical, consider an employee who is 50 years old who just started at a new company after working as a freelancer over their whole career up to that point. This person is making $70,000 per year. How long would it take them to reach $1 million if they contributed the maximum amount?
Including the catch-up allowance for those 50 and over, this person could contribute $27,000 per year. That would be almost 40% of their salary. With the 4% company match included, they could reach $1 million in just over 17 years, just in time to collect Social Security at age 67 -- assuming a 3% annual raise, a 4% company match, and an 8% investment return.
Scenario one is definitely the easier route, as you can spend and enjoy more of what you make while you are making it. And you can obviously get there faster, or exceed $1 million, if you increase your contributions over time. But if you find yourself playing catch-up, maximizing your contributions can help you reach your goal.