What has the biggest impact on your 401(k)? Is it how much you save or how you invest?
Both are clearly important, but if you’re counting on knock-your-socks-off investment results to pay for that retirement condo in Hawaii, you may want to rethink your strategy.
In fact, it’s the amount you save and contribute to your retirement plan that has the greatest impact on the end results.
“Even if you have the Midas touch when it comes to investment performance, it’s impossible to grow $0 saved into a retirement cash flow. Participants must understand that the amount of money they save has a greater importance and impact on their overall retirement well-being than which funds they select,” says Layton Cox, Director of Retirement Plan Consulting at Pathways Financial Partners in Tucson, Arizona.
Studies by researchers at Wharton and other institutions have clearly confirmed that saving for retirement is more important than investing for retirement.
“If someone needs to be saving 12% and is only saving 3%, investment performance is not going to make a difference,” echoes
That’s not to say that selecting better investments for your 401(k) doesn’t help increase your final balance at retirement. It does.
So does improving your overall investment allocation and diversification.
But the biggest difference of all comes from boosting the percentage you contribute to your account.
Take a look at the graph we put together (below) showing the dollar impact on your 401(k) balance of different savings and investment strategies, based on a 2014 study by the Empower Institute. Our typical worker – let’s call her Sarah – starts at age 28 and saves 3% of salary until age 58. Despite her modest contributions, conservative investments and a strategy of selecting the lowest-ranked funds, she still ends up with $205,551.
Here’s what happens when she mixes it up:
Surprisingly, experimenting with different investment strategies like using only index funds or top-ranked funds made her results worse, not better.
If Sarah had a crystal ball, and invested in what turned out to be in retrospect the “best” performing funds (something not usually possible in real life), Sarah’s nest egg would have grown an extra 10%.
If she ditched her conservative strategy, and went for a balanced allocation with improved diversification, she could have added almost 40% to her final nest egg.
However, just adding 1% to her annual salary contributions (from 3% to 4%) packed nearly the same punch with lower risk.
But here’s the kicker. Sarah can more than double her retirement fund balance by doing just one thing – gradually increasing her contributions by 1% each year, starting at a lowly 3% and ending at 10% of salary (see our previous articles on why all workers should target savings of 10-15% per year).
The Takeaway: Just imagine the impact on Sarah’s account if she combines all these winning savings and investment strategies. Do you want to maximize your workplace savings so you can enjoy a fun and stress-free retirement? Careful investment selection and good diversification are essential, but the biggest impact will come from contributing 10% or more of salary to your plan. If you can’t do it all at once, step it up by 1% each year.