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Retirement Account Investment Performance Series
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How to Magnify the Return On Investment for Your 401(k) Retirement Account If you have ever cracked open a financial magazine, you have surely heard you should maximize your investment in the 401(k) retirement account if your employer offers one. There are four major reasons to do this: (1) employers normally match a portion of your contributions which means you immediately receive free money, (2) your earnings grow tax-deferred, (3) you reap the tremendous benefits of compounding over decades of reinvesting your earnings, and (4) the Government effectively subsidizes your contributions by reducing your taxable income for each dollar you contribute which reduces your tax bill. It’s true; you will most likely never find a better investment for your future besides owning your own home. However, are you getting the full benefits of your 401(k) investments? This article will show you a simple technique you can use to increase your future wealth by tens of thousands of dollars or more. The “magic of compounding” occurs when you invest money and reinvest the earnings from your investment each month, quarter, or year. By doing this, the next period you have a larger investment which generates higher income. Over the long term, your investment will compound and get larger and larger until you have an amazing balance. For example, if you invest $5,000 one time in an investment that yields 1% growth per month, the magic of compounding will turn your $5,000 into $98,942 in 25 years. Another popular investment technique
most people automatically use when investing in 401(k) accounts is
called, “Dollar Cost Averaging”. Dollar Cost Averaging is simply
investing a fixed amount of money each paycheck which generally occurs
every two weeks or once per month. By investing a fixed amount each
paycheck … let’s assume you invest $200 per paycheck … your $200
investment will buy more shares of the investment when prices fall and
fewer shares when prices rise. Thus, dollar cost averaging takes
advantage of share price volatility. There have been numerous studies
conducted revealing the net effects of dollar cost averaging. Many of
these results are available in a powerful little book called, “Growth
& Income”, written by Dr. Bryan Stoker and published by Lifestyle
Publishing (www.LifestylePublishing.com/gi.htm).
Without getting into the details, let me just say the net effect over 20
to 30 years based on the historical performance of the Maybe 2% per year on average does not sound like much, but let’s consider the example above. Assume you invest $5,000 one-time and then add only $200 per month. At 12% returns per year (i.e., 1% per month), your balance would be $474,712 after 25 years. As you can see, simply adding $200 per month provides a tremendous boost over the one-time investment presented in paragraph two. However, if you boosted your average annual rate to 14% instead of 12%, your 25-year balance grows to $701,421. That’s an extra 226,709 simply due to the increased effective return. Clearly dollar cost averaging adds tremendous value to your financial future, but what if there were another simple way to add another 1 to 2% to your average annual return? As it turns out, there is! It’s called, “Asset Allocation”, and this is how it works. First, you should diversify your investments in your 401(k) simply for safety. Let’s assume your 401(k) offers three different mutual fund investments. Let’s assume you have an S&P 500 index fund, a small growth stock fund, and an international fund we’ll call the C fund, S fund, and I fund respectively. Let’s also assume you are comfortable investing 40% of your 401(k) dollars in the C fund, 30% in the S fund, and 30% in the I fund. These percentages are your “allocation” between investment types. Over time, the growth and decline in share values will vary between the C fund, S fund, and I fund. For example, over a six-month period, the C fund and S fund might rise by 4% and the I fund might decline by 2%. The end result is the value of your C fund investment and S fund investment will be higher, and the value of your I fund investment will be lower. At this time, the percent of your total cash in the C fund and S fund might be 32% each and the portion of cash in the I fund might be 39%. If you simply adjust your allocation back to the original 30%, 30%, and 40%, you will sell some of the C fund and S fund and buy some of the I fund. Thus, you will “buy low” in the I fund and “sell high” in the C and S funds. Six months later, the I fund and S fund may be higher while the C fund has declined in value. Thus, you would adjust once again back to 30% C fund, 30% S fund, and 40% I fund. Once more, you would “sell high” and “buy low”. The net result of re-allocating your cash every six months (or whatever period you choose) will be an effective increase in your average return. The net increase in average return increases as the total time you invest increases and as the volatility of your investments increases. Furthermore, the more uncorrelated the investment choices in your 401(k) are, the stronger the impact asset allocation will offer. Regardless of these factors, however, you will actually lower your risk and boost your net returns simply by using asset allocation in your 401(k). If the net effect was simply another 2% increase in average annual returns, your new balance in the example above would $1,048,478. To learn more about these and other techniques you can use to boost returns in your 401(k), 403(b), individual retirement accounts, and even taxable mutual funds, check out the book, “Growth & Income” by Dr. Bryan Stoker published by Lifestyle Publishing. Simply click here to read more about it: www.LifestylePublishing.com/gi.htm.
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