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How to become a 401(k) millionaire in four easy steps
Thursday, February 12, 2015 by Scott Fraser

If it weren't for the tripwires of human behavior, becoming a millionaire would be a pretty easy path to follow. It's mostly math and good habits.

So when I came across this piece on nowitcounts.com, a Web site for investors over 50, I saw a clear message: If you save consistently, the miracle of compound interest will make you rich.

The good news is that there's no secret as to how this works. In fact, many people have followed this path: At least 70,000 Americans are now 401(k) millionaires, a number that has doubled since 2012, according to Fidelity Investments.

How is that possible? Weren't people supposed to be out of the market and losing money in the wake of this generation's largest financial debacle?

Well, not everyone was out of the market. Millions kept putting money into their 401(k)s as the market climbed.

Stocks alone have more than doubled (as measured by the S&P 500 index) from 2009 through 2014 -- up 168% with dividends reinvested.

That's an 18% annualized return that you could've roughly achieved by doing nothing by holding a no-brainer index fund like the SPDR S&P 500 ETF (SPY), which only charges you 0.09% annually for holding all 500 stocks in the index.

 

Becoming a 401(k) Millionaire

So how does the 401(k) Millionaire plan work? Here are four essential things you need to do:


1. Save 10% to 15% of Your Salary -- or More.

This is boiled down multiplication. The more you save, the sooner you'll become a millionaire.

Plus, you don't have to worry about taxes until you pull the money out at a future date.

According to nowitcounts.com:

"Fidelity’s 401(k) millionaires had an average company contribution of 5 percent. In addition, those millionaires deferred about 14 percent of their pay over the 12 years they were studied, amounting to $13,300 a year. That made their total savings rate 19 percent. IRS rules allowed people to defer up to $17,500 of their pay in a 401(k) account in 2014 and as much as $23,000 if you were 50 and older."

 

2. Invest in Stocks.

Let me refine this a bit: You need to invest in as many stocks as you can from all over the world.

Stocks have earnings and dividends. They pay you for being an investor and taking risk. Bonds don't do that.

A fund like the Vanguard Total International Stock ETF (VXUS) owns nearly 6,000 stocks from across the planet. If you need a single stock holding, this would be a bad choice.

"The 401(k) millionaires had an average of 75 percent of their assets in company stock and stock mutual funds. They had a median return of 4.8 percent over 12 years. Coupled with the contributions of themselves and their employers, their account grew 8.75 percent a year."


3. Take the Employer Match.

This is the biggest financial no-brainer of all time. Somebody else is paying you to invest. It's free money!

"When it comes to the millionaires, 28 percent in their account came from the employer and that boosted annual savings by nearly $4,600."


4. Don't Cash Out.

Your 401(k) is not a piggy bank and it's not an emergency fund. You should, of course, keep money in a money-market fund for rainy days, but it shouldn't be in your 401(k).

The simple truth is that your money can't compound if you pull it out and Uncle Sam will nail you with taxes and an early withdrawal penalty (before age 59 1/2). It's not worth it.

So there you have it.

Save early and often and go for growth. Leave your money alone. If the stock market makes you nervous, keep only 60% in stocks and the rest in bonds and cash.

Although 401(k) vehicles are often flawed because of high expenses that you may never see, if offered the chance to save -- and receive a matching contribution -- there's little reason to pass it up.

 

 
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