We make decisions every day.
What shirt should we wear, what pants, how much milk to pour in our cereal? Many of the decisions are so small we don’t realize we are making them.
Other decisions though are a bit larger. Whether to buy that new car or use cash to pay off a student loan or buy that new house. These have greater impacts on our future and tend to require much more thought.
What if I told you that one decision, a simple elect or not elect, could mean an additional $81,000 in 30 years? Would you try to learn more about what this decision entails?
I know I would.
Many of us shy away from this question and decision altogether, though, not even necessarily making the wrong decision. We keep ourselves from even playing the game.
The decision is whether or not to contribute to a 401k… electing to contribute and selecting an amount to contribute.
This is another classic example where we hurt ourselves because of an inability or lack of desire to overcome a major investing hurdle - acquiring knowledge.
We all want $1 million, but then what do we do with it?
Let’s fast forward for one second, and put ourselves in the position when we have $1 million in savings.
What does this mean?
In Wela’s view, it means that you can have a nice cash flow on a monthly basis without touching the original $1 million.
Ok, that seems a bit like finance jargon, so let’s make it relatable.
Currently, an individual has the ability to lend the government money for 30 years. The government will pay you $3.30 for every $100 you lend them. They pay this every year for 30 years and then give you back the $100.
That means we can take our fresh million dollars and put it in a 30-year bond (which, by the way, is deemed to be the safest of investments because if the government fails we have much greater worries) and get $33,000 a year for the next 30 years. And then get our million dollars back in 30 years. Not bad!
This is how we can make our money “work” for us.
The $1 million fork in the road
Now it’s time to get back to reality.
It’s great to plan out how to use our million once we have it, but what about ways of getting to that point of having $1 million?
Let’s cut to the chase. If you want $1 million in 30 years, then you need to save $15,051 every year. You will also have to earn 5% per year on the amount that you’ve already saved. If you are able to accomplish both of these tasks, the dream of $1 million becomes a reality in 30 years.
We also have another choice that we need to make, and this is the one that could net us some extra dough. It’s back to the elect or not elect decision. Should this money go into a 401k (or 403b for government employees) or not?
This scenario will take someone who makes $60,000 and has a federal tax rate of 18%. If this person were to save their $15,051 in their 401k every year then they would have an additional $2,700 every year as opposed to the person that decides to not save in their 401k.
The reason that this occurs is simple. By contributing the entire $15,051 to our 401k, we are able to reduce our taxable income by that amount. Thus, the $2,700 we have is basically what we are saving from taxes. The additional money actually finds its way into our bank account instead of the government’s account!
Ok… seems great, but that doesn’t look like $81,000 to me.
Ah, but think about if we were to get an additional $2,700… every year? That would be the additional $81,000 (30 x 2,700).
We had to make a couple of decisions before getting to the fork. First, do we want to have $1 million in 30 years? Then, do we want to commit to saving $15,051 every year to get there? If so, you have now reached the fork in the road.
The extra payoff
Now this is where things get fun.
Remember that extra $2,700 we could have every year? Well that could be worth $81,000 if we were just to put the extra cash under our mattress.
But if we were to put that into a savings account that paid, maybe, just 3% per year for those 30 years… we could be sipping a few extra daiquiris in retirement.
By saving $2,700 every year and earning 3%, we would have $128,000 as opposed to just $81,000. That’s a nice bump!
And remember our fast forward look at what we could do with $1 million dollars (create cash flow of $33,000 per year if you forgot)? Well, if you add in that additional $128,000 we just saved, the annual amount we could get would be $37,000. Not too shabby!
Turning theories into realities
In life, we make many decisions that create instant results. These tend to be the decisions that my generation likes to make. I am no different.
Instant gratification is the world we live in today. Technology has created this. We don’t need to go to the library anymore to get the list of every president. We can do it via our cell phones.
If we need to get in touch with someone, we call them or text them. We don’t have to page anyone anymore, and wait for them to find a payphone. Those days are past us.
Oftentimes, we try to get that same instant gratification with investing. Unfortunately, that hasn’t been created yet. Although it may look like these tech companies are creating millionaires and billionaires like chickens produce eggs, but there is actually a lot of time and work that goes into creating that technology or company.
For those of us that are trying to get to that millionaire level by investing and savings we have to understand that it takes time and commitment. It also means we must be constantly learning along the way and make decisions… decisions that may not create an instant result.
The elect or non-elect decision with regards to your 401k is a decision that won’t impact you for years, but the impact is great. Remember, even if you don't have $15,051 to put away every year right now, start with what you do have now that you can put away. That will get you started on the path to being a millionaire, and put the power of time and compounding on your side.
Yogi Berra (a hall of fame baseball player) once said, “When you come to a fork in the road, take it.”
So, here is your fork; will you take it?