I recently met with some human resources personnel -- long story, I'll skip the whys and wherefores.
They walked me through their services with a snazzy presentation. Some of the slides had video; they showed an HR representative ("Sally") meeting with a new hire ("Kyle"). In one segment, they were talking about the 401(k) plan. Sally explained that for each dollar Kyle contributed to his 401(k) he received a company match, up to 7.5% of his salary, to a limit set by the IRS. It showed an animation of a pencil calculation of a 10% contribution.
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Okay so far. Then:
Kyle: How much money should I put in my 401(k)?
Sally: That's up to you. There are some calculators on the website that let you try different scenarios.
Kyle: I'll have to check them out [looks at papers]. Which mutual fund do I pick?
Sally: Well, I can't give you personal financial advice. But a couple of years ago we added the funds that have a year in them. You just pick the year you plan on retiring, and the fund does the rest.
Kyle: That sure makes it easy. [Circles his fund choice, hands back the form and smiles.]
I'm sure this was designed with good intentions. Let me tell you the effect. A new report from mutual fund leader Vanguard says data from its client accounts as of April showed that, for the first time, a majority of 401(k) account holders had only ONE fund. It's not an index fund, either, it's a so-called target-year fund just like Sally was peddling.
I know she was trying to be helpful in a scripted video showing how the HR process works and all the i's that have to be dotted and t's that need to be crossed. I know she was doing what she had been trained to do in an effort to be compliant with the jillions of rules that govern the workplace and are meant to protect employees.
I also know Vanguard would like to think that it has done a genius job of marketing these funds, which invest a blend of stocks and bonds suited to maximize growth and minimize risk based on the time until retirement. I'm willing to concede that these funds, if nothing else, sound good. They're designed to provide exposure to equities early on and move into fixed income as retirement approaches.
But what really happened here is that Sally the HR Lady "sold" this fund. Kyle had a question -- and one about a pretty big decision at that -- and a person in authority who knew more than he did gave him an answer he found credible. Problem solved, issue disposed of, form filled out.
These funds, to be sure, are not naive, bad or evil investments. They aren't perfect, either. And I predict this will become a scandal of some magnitude in the next year or two. But the broader point is that investors have to know what they are buying and how a security can reasonably be expected to perform.
That's pretty much all my premium Fast-Track Millionaire subscribers and I do, of course. In our case, we're on the hunt for those rare stocks with quadruple-digit gain potential. (Sounds crazy, right? But we usually find at least one per year with this strategy -- and a host of triple-digit winners to boot.)
But if you have children or grandchildren who are dutifully socking money away in 401(k) plans, you might broach the subject with them. Any financial adviser would be thrilled to bill an hour to run Time Value of Money calculations to help them develop a plan.
Having a plan is so important, and most 401(k) investors simply don't have one.
The fact is, this sort of planning is simple -- it only takes one number. That's the figure that will generate "x" dollars of income per year of retirement. (These are two annuity calculations: the pay-in generates the projected retirement year balance; the payout version subtracts the withdrawals while adding in the anticipated returns.)
Once you have that a desired retirement year balance, determining The Plan is not some huge scary deal, it's nothing more than a math problem. One need only to backfigure the arithmetic to see, given a known amount of time and a rational expectation for return, to arrive at a monthly pay-in number. Make that payment religiously over a period of decades, and, presto, you will wind up pretty close to the target account balance.
For investors with a long time horizon, such as recent graduates, a modest monthly contribution of as little as $250 easily can build a million-dollar-plus nest egg. Saving a million bucks is a goal that scares people -- the fact is, they won't even try because the number seems impossible. But tell someone that if they invest $237.75 a month and they start thinking about how they can actually do that -- it seems more real and more achievable, and it is.
I recently found a guy in Nashville to have this chat with my little sister, who's just moved there with her gorgeous young family and taken a new job. I'd have run these calculations for her, but she's been suspect of my advice ever since I told her crickets were okay to eat when she was 4. (Now she's got a Ph.D. from Princeton and schools her big brother pretty much all the time.)
If you have a kid or grandkid who's fresh out of school and will be having a chat with an HR person like Sally, you might think about what you can do to send them into that conversation with some good information and the outline of a plan. Worth considering.
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This article originally appeared on StreetAuthority.com.