Warren Buffett is sometimes referred to as the “Sage” or “Oracle” of Omaha, as his wisdom is so widely followed in the investment community. But even in his prime, not even he could consistently deliver 46% returns year in and year out.
Amazingly enough, those kinds of returns are offered to the vast majority of employed Americans. And even better, they are offered with absolutely no market risk… or any risk at all, for that matter.
And they come from what is perhaps America’s most conventional of investment vehicles: the 401K.
That’s right, that boring collection of mediocre mutual funds can generate 46% risk-free returns every year — but only if employed correctly, which, as Harry mentioned last week, most Americans don’t.
It comes down to two important factors:
- Employer matching
- Tax savings
Now, not all employers offer matching, and some employers are more generous than others. But many recognize the importance of maintaining a happy workforce, and the tax code further incentivizes employers to contribute to your 401K on your behalf. A common matching level these days is 6%.
Let’s say your salary is $100,000 and you contribute 6% to your 401K plan. That $6,000 instantly becomes $12,000 if your employer matches at that level. You just doubled your money right there!
Taxes make the situation even better. Since every dollar you divert into your 401K avoids taxation, you effectively “earn” whatever you don’t pay in taxes. So if you had a fantastic year and find yourself in the highest marginal tax bracket of 39.6%, you’re saving close to 40%.
Combine that 40% with the 6% your employer matches, and you’re at that golden 46% return! And I haven’t said a word about investment returns on your 401K…
OK, I realize few Americans fall into the top marginal tax bracket, but even at the 25% mark, you’re still looking at remarkable savings, plus whatever your employer matches.
This may be an unconventional way of looking at your 401K, but here’s the big picture: You should absolutely max out your 401K every year. If living expenses prevent you from doing so, get as close as you can.
You can put $18,000 of your own money into a 401K as of 2015, and that doesn’t include employer matching. If you’re 50 or older, you can chip in an additional $6,000.
Don’t miss this opportunity. Too many people fritter away their money on senseless expenses, from weekend getaways, fast cars, or houses they can’t afford.
Don’t be one of those people.
P.S. There was a stretch in the 1960s when Warren Buffett really did generate those kinds of returns… but, we won’t split hairs.