Should You Invest in a 401(k)?

Around about a year ago, Census.gov published what to me is a quite alarming report on ownership of retirement accounts in the U.S. The overall percentage of people with savings for their retirement was shockingly low, but when you get to the demographics in the report, it makes for really depressing reading. For example, only 7.7% of those in Gen. Z (Ages 15-23) have any form of retirement account and less than half of millennials (24-39) have started to save for their old age. The Gen Z number is understandable given that most of that age group is still in school, but if you haven’t started to save by the time you are nearly 40, you are creating a big potential problem for yourself.

One could argue that older Americans, the Boomers, have an excuse in that many of them will still have defined benefit pensions available, but those were essentially phased out around 30 years ago, so anyone under the age of 55 is going to be completely dependent on retirement savings to supplement their Social Security when they can no longer work, or don’t want to. Given that, savings levels as low as they are for younger Americans are going to cause a lot of misery and disappointment in a couple of decades.

In some ways, I get it. Recent college grads, or anyone else entering the workforce for that matter, face a number of financial problems right off the bat. Housing is expensive, whether you choose to rent or look at getting a mortgage with rates as high as they now are. Many face the prospect of repaying substantial student loans. And they want to live -- they are finally earning and want to enjoy being single and unencumbered. Or, if nothing else, those student loans look scary, and paying them off is their priority.

However, simple math tells you that allocating even a small percentage of your earnings to saving for retirement as soon as you start receiving a regular paycheck is the right thing to do.

Let’s start with the obvious. Most employers offer some kind of a match when you contribute to your 401(k), so if you contribute, say, 5% of your gross salary each pay period, they will add another 5% to your account. To not take advantage of that is effectively taking a voluntary 5% pay cut. This is free money, and not taking it makes no sense.

Then there is the impact of compounding. This chart, taken from a recent US News article, shows the difference in outcomes based on when you start saving $100 each month. Starting at 25, you will have over $250,000 more at age 65 than if you started at 35 years old, even though you would have only contributed $24,000 more. Take that in for a moment -- you would be adding an extra zero to your savings just by starting a decade earlier.

One of the arguments against investing in a 401(k) is that now is not a good time to start, given that the market is at or near all-time highs, or is falling right now, or whatever. Those objections, however, are easy to refute. If the market is at its highs, that just shows that, over time, stocks go up, which is why the more time you give yourself, the better the results. And if it is falling, what better time to start buying regularly than when something that has always gained over long time periods is falling due to short-term issues? You're essentially buying something at a discount.

Then there are those who say they don’t invest because they know nothing about the stock market. However, the beauty of contributing to a 401(k) is that you don’t have to. Most plans offer what are known as target date funds, where your money is divided up between riskier investments that offer the possibility of higher returns and the less risky with lower yields that give some stability, then that ratio is adjusted over time to reduce volatility once you have built your nest egg.

In short, there really is no excuse for not taking advantage of a 401(k) if you have the opportunity. The money is taken out of your paycheck directly, and one of the things that I've learned over forty years of earning, with variable incomes from the high to low, is that my net income had very little if any impact on either my happiness or what I had left in my bank account at the end of each pay period. I spent what I earned, even when that was a large amount. Taking money out of my paycheck before I had a chance to spend it was a way of making sure that I paid myself first. So, if your employer offers a 401(k), particularly one where they match your contributions up to a certain percentage, take that opportunity. Your future self will thank you if you do.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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