Here’s a question you probably haven’t heard from financial media before: When shouldn’t I invest in a 401(k)? Conventional wisdom would tell you that’s absurd - everybody knows the best thing to do is invest as much as possible for as long as possible because “compound interest is the most powerful force in the universe” (Einstein). But this post is pulled from an article called “Rogue Waves”, so let’s look at that question from a different angle. Einstein is not wrong about compound interest. Let’s say you invest $5,500 per year into your 401(k) or IRA, and it grows long-term at 7%: Let that chart sink in for a second. For most people working today, “full retirement age” is 67. That means most millennials have close to 40 years before retirement. Want to have a $1 million nest egg so you don’t have to work through retirement? Invest $385/month and you’re there. Take that, gravity.
Longer investment horizons are also great for smoothing out market volatility. What does that mean? It means that if you have 20+ years until retirement, you care a lot less if the market crashes this year than someone who is retiring in June. That last scenario is a justification I hear for why people don’t contribute to a 401(k) - they are close to retirement and don’t trust the stock market. Unfortunately, that is a terrible excuse. Every 401(k) plan has a money market or stable value fund you can put your money in - this money isn’t invested in the stock market, it’s just cash. Pretty much every 401(k) plan also has a company match. If you don’t contribute, you can’t get the match, and that means you’re passing up on free money (never a good idea). So when shouldn’t you invest in a 401(k)? There are two scenarios: 1) Don’t put after-tax money into a Traditional 401(k) or IRA. I have seen this option both on a workplace benefits website and as a question I get for what to do with year-end bonuses. It's really not worth the hassle of keeping track of the paperwork for the next three decades, you’ll probably just end up paying tax twice on that money (that’s over 60% if you’re in the top brackets!). 2) If all your savings are tied up inside your 401(k) plan. Let’s say you’re late 20’s/early 30’s making $60k/year and putting 8% into your 401(k). Great start! Just be a little bit careful here about something - 401(k) and IRA money usually carries a 10% penalty if you touch it before age 59½. A lot of expenditures tend to come up between ages 30 and 60: buying a house, getting married, having kids, paying for said kids to go to college… Paying a 10% penalty because all your savings are inside a 401(k) or IRA is not ideal. The best thing to do is have a standard brokerage account alongside your retirement savings. That way, your money is still working for you but is also accessible penalty-free when needed. The earlier you start investing and putting your money to work the better off you’ll be down the road. Just make sure you’re not setting yourself up for any unnecessary detours or roadblocks as you go. Comments are closed.
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