Small Changes Now Can Mean Big Long Term Results

May 08, 2015

In a conversation I had recently with an employee of a large healthcare company, the topic of retirement planning and investing merged together. She had recently started her job and wanted to be sure that she got off to a good start. Her prior employer had no financial wellness benefits provided so this was her first conversation with a financial planner. The conversation was very revealing about her views of herself, the world of investing and the level of financial knowledge that many people who work in financial services business assume that individuals have when they walk in for a conversation.

At 30 years old, she had done a great job of doing the financial basics. Her level of credit card debt was minimal, and in most months, she paid off her balances entirely. Only a new washer and dryer were on her credit card, primarily to earn points for travel, and she planned to pay off the balance in two months.

Her student loan balances had been completely paid off. She had between 3 and 6 months’ expenses in savings. Her biggest financial asset ($35,000) was her prior employer’s 401k plan, and she was in the process of transferring that to her new employer’s plan. Her financial position was quite strong for someone her age.

Even when things look good at first glance, it’s always a good idea to dig a layer deeper.  When I did that, I found something that surprised but did not shock me. While she had all the right pieces in place in much of her life, her 401k plan had a few things that could definitely be improved.

Problem #1: She was contributing 3% to her 401k plan. The company was matching that 3%, so she had a total of 6% going into her plan. That was nice and it would continue to grow dollars toward her financial future but it could be SO MUCH better with one slight tweak.

Her company would match dollar-for-dollar up to 6%. Given her income and ability to save, increasing her contribution (which was set by the auto-enrollment policy of her employer) would fit into her budget. A rough calculation based on her income ($75,000/yr paid 2x/month) showed that with pre-tax contributions, her pay would decrease by about $60-$65 per pay. In exchange, with the company’s increased match, she would have ~$170/pay deposited into her account. That’s nearly a $3 for $1 trade.

Takeaway: Always find a way to contribute up to the maximum that your company matches.

Problem #2: Her company gives annual salary increases and she had no plan to capitalize on that. We talked through her expected annual increase in the following year, and it would be in the neighborhood of 3%-4%. The midpoint (3.5%) translates into a $2,625 increase, or about $100/pay period and maybe $70-$75 after taxes. While that’s nice, it’s not exactly life changing. But using her plan’s contribution rate escalator feature, it could be life changing.

Takeaway:  Make it a top priority to increase your 401k contribution every single time you get a pay increase!

Problem #3: She “lost everything” in 2008 and it left her very skeptical/scarred. Because of her ’08 experience, she had 100% of her account balance in her plan’s stable value option, which is a hybrid of a money market and a government bond fund. The current rate of return on her plan’s stable value fund is between 1.5% and 2%.

With inflation being roughly 2%, she may actually be losing purchasing power  over time.  She is not at all interested in investing so we talked about the merits/drawbacks of target date funds. If her rate of return could be 5-7% over time, she could be significantly better off than with her stable value fund.

Takeaway: Don’t let one bad experience taint how you act in the future. Remember your time horizon and ability to withstand a series of crashes/corrections in the market followed by extended periods of rising markets. Investments usually run in good/bad cycles and patience is generally rewarded. Know your investment risk profile and invest accordingly.

Results: Using some realistic assumptions, her 401k would have grown to over $550,000 at age 65 under her current course of action. Bumping the contribution to 6% would take the age 65 balance to $1.1 million. Adding the rate escalator at 1%/year would take her to $1.6 million.  And getting a 6% rate of return takes her to a projected $2.6 million. A few subtle tweaks on a random Wednesday afternoon could add as much as $2 million to her life. She walked out of the meeting feeling much more secure about her future and it was all going to happen with very little change to her daily life.