I never participated in 401K account for the first 10 years of my career. My reason was I would lose money since I might buy at a market high and sell at market low. This is a common fear in most of us. Not fully understanding a 401K plan and its purpose was the reason for my fear. Gaining knowledge and getting started with participation in 401K helped me overcome that fear.
Suppose you invested $1000 in your 401K plan every month in SPY index fund from 1993 to 2019(26 years). You would have accumulated 4000 units of this index fund. I have NOT included the dividends, expense ratios and management fee for simplicity. If included you would have way more units of this index fund due to compounding. Being conservative, 4000 units would be worth around $1.1 million and actual amount invested would have been $315,000. These 4000 units would earn you a dividend of $20,000 per year today which is $1,667 per month . This is more than what you invested every month in the 401k plan.
What if you retired in the worst recession? Let’s say February 2009. You would have invested $194,000 and would have had 3200 units of the index fund which would have been worth $192,000 not including the dividends, expense ratios and management fees. Your 401K is down by $2000 even though the market is down by 55% from all-time high. Dividends for 3200 units for 2009 amounted to $7000. Not bad!
Now I am NOT suggesting you need to invest in SPY. You may NOT have that fund in your 401K plan. Any low cost index fund tracking S&P 500 will do the needful. I personally like Vanguard.
Based on these numbers I learned the following.
- 401K contributions every month facilitated dollar cost averaging which protected the portfolio value against worst recession of all time.
- Magic of compounding kicked in due to the long time horizon.
- Stick to the plan and do not sell when market is down (longer the better).$192,000 in 2009 grew into $1.1 million in 2019.
- 4 percent of $1.1 million is $44,000 per year which is $3,666 per month. Using 4 percent rule this money will last for at least 25 years.
I am sure there will be taxes and many other things that might go wrong. However, not participating for the first 10 years of my career was undoubtedly a massive mistake on my part.
My plan was to regularly invest from every paycheck in a low cost Index fund available with my 401K plan for as long as possible. Never cash out until retirement and upon retirement withdraw every month certain amount capped at 4 percent of the total amount available. Apart from my 401K account I realize I need to have other savings and sources of income for a comfortable retirement. Better late than never!
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