As I wandered through the allfinancialmatters.com blog the other day, I saw an eye-opening quotation from a Wall Street Journal article: "About 40% of workers in their 20s and 30s said they had cashed out their 401(k)s or 403(b)s when they switched jobs, according to an online survey of about 1,200 people conducted in January for Fidelity Investments by CMI, a research firm."
Yowza! Clearly, financial illiteracy remains a big problem in America. If these folks knew more about the importance of saving and investing and about how money grows, they'd behave differently.
Let's consider an example. Say you're 30 years old, and you cash out a 401(k) account with $20,000 in it. To you, it's a little windfall, enough to buy you a new car, or maybe pay down some debt. You need to think about what else it could be, though.
If you plan to retire at age 65, leaving that money alone would give it 35 years to grow. If it grew at the market's historic average annual rate of 10%, it would ultimately become about $560,000 -- more than half a million dollars! And that's without adding anything further to the account. If you then withdrew 4% of that money each year in retirement, as has been suggested in our Rule Your Retirement newsletter service, you'd yield $22,400 per year. See what you're throwing away if you cash out now?
Topping $22,400
If you choose outstanding stocks or mutual funds, you might even earn more than 10%. Check out these average annual returns for some familiar names:
|
Company |
10-Year Average Annual Return |
|---|---|
|
ConocoPhillips |
16.5% |
|
Union Pacific |
16.7% |
|
Tiffany |
14.1% |
|
MGM Mirage |
13.7% |
Data from Morningstar.com through 6/30/08.
Many mutual funds can serve you well, too. The Manning & Napier World Opportunities A (EXWAX) fund, for example, sports a 10-year average of 12.7%. Its top holdings recently included Unilever
If your $20,000 nest egglet grows at 13%, on average, yearly, in 35 years it will turn into a rather hefty $1.44 million. Just look at that! It's just about enough for most of us to retire on, especially if it's supplemented with Social Security or some other income. Withdrawing 4% of it yearly will give you an annual income of $57,600 to start.
Why so much
If you're wondering how an entire retirement could be based on a 401(k) account that was left alone after the owner turned 30, the answer is compounding -- and the power of time. You could duplicate the results by saving and investing in your 30s or 40s or 50s, but you'd have to save and invest a whole lot more each year. The beauty of early money is that that it has so much time to grow, even if it doesn't seem like a princely sum.
Remember: A dollar today can do much more for you than a dollar five or 10 years from now can do.
Other considerations
Here's a simple, additional reason to leave your account alone: early withdrawal penalty fees. Why fork over 10% of that bundle when you can just leave it to grow -- especially since you'll be paying taxes on the sum upon withdrawal?
Also, don't think that you're limited by just the funds available in your 401(k). If you're leaving your employer, you can roll all your money into an IRA, where you can invest in all kinds of funds, individual stocks, and even bonds.
Take advantage
Learn much more in our 401(k) guide and our IRA Center. And for detailed guidance on retirement planning, you can test-drive our Rule Your Retirement newsletter service for free. A free trial will give you full access to all past issues. It regularly offers recommendations of promising stocks and mutual funds.
