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What Does It Take to Have a $1 Million 401(k)?

Saving a considerable amount for retirement might not be as hard as you think.

Editor's note: This article originally ran on Sep. 5, 2019. It’s since been updated to reflect new data.

Let's say your goal is to save a million dollars by the time you retire. For many people, that sounds like a Herculean task.

What are you picturing right now? If you are imagining squirreling away money for decades and holding it in cash (which has returned 0.4% after inflation* over the past 90 years), you would need to sock away a lot of money to get to a million. And along the way, your budget could be really tight.

Change your mental picture. Instead, invest in your 401(k) (or another retirement savings account) with the goal of having a million dollars in 30 to 40 years. Although it may sound like it's just semantics, it's actually much easier--especially if you start saving early--to let your investments do as much heavy lifting as possible.

What Does It Take? You can contribute up to $19,500 to a 401(k) in 2021. But the good news is that you don't have to save anywhere near that much per year if your goal is to have a million dollars at retirement age (65), provided you start early. The earlier you start investing, the longer your investment will compound (your money will grow exponentially). You can do the math yourself if you have a financial calculator, but in case you don't (or you don't have it handy), here's an example of a 25-year-old who has not yet begun saving.

What about that market rate of return? How do I know what stocks will return over the next 40 years? The truth is I don't, and neither does anyone else. If we did know, we would know exactly how much we need to save to reach our goal. But since we don't, we will make educated guesses instead.

Here's how I came up with 7%. Over the past 90 years, stocks (as benchmarked by the S&P 500) have returned about 10% per year on average. Adjusted for inflation (which is referred to as the "real" return), stocks have gained around 7% per year on average. Does that mean the S&P 500 will earn around 7% after inflation in every year going forward? Of course not--this is just the smoothed-out, average annual return over the past 90 years. Importantly, there is just no accurate way to guess what stocks will do over short-term periods. Over a multidecade period, though, 7% per year is as reasonable an estimate as any.

Again, though, there are no guarantees. If you want to be more conservative in your estimate, you can use 6% or 5% as the return for stocks. The result of lowering the growth rate will be that the recommended savings amount rises: In other words, the market won't do as much heavy lifting and you will have to save more. The downside of saving more in the present is that you may have to keep a pretty tight budget, which can be challenging. The upside, obviously, is that you'll have more money saved.

Don't forget: Part of your contribution might come from your employer in the form of a company match. Let's say your employer matches the first 5% of your 401(k) contribution at $0.50 on the dollar. That means that if you save at least 5% of your paycheck ($2,000 if your base salary is $40,000), your employer will kick in $1,000. So that means that you only have to save $4,000 per year (10% of your salary) to get into the ballpark you want to be in.

Is a Million Going to Be Enough? Now that we've figured out how to save a million dollars, we should ask ourselves if that's even an appropriate target. It's a considerable amount of money and it's a lot more than many people have when it comes time to retire. But if you have many decades until retirement, inflation takes a toll and you might find that a million dollars just isn't a whole lot of money.

The goal in retirement savings and drawdown is to maintain your current lifestyle, plus or minus some expenses--maybe more travel spending but less money required for commuting and new clothing. Many people focus on replacing 80% of their preretirement paycheck. Remember, too, that Social Security will provide some income in retirement. Also--and this is something that people sometimes forget--you still have some earning power in retirement, especially if you maintain a modest allocation to stocks in your portfolio.

For that reason, it's recommended that you base your savings goal on your household's anticipated cash flow needs rather than on an arbitrary number. For example, Fidelity periodically releases recommended age-based savings benchmarks expressed in terms of multiples of salary (see this article in Fidelity Viewpoints).

These savings "guideposts" are Fidelity's, not Morningstar's. I think they they are pretty decent benchmarks. The problem with homing in on a dollar amount is that it might be a lot more or a lot less than you will need in retirement, depending on your current salary and lifestyle.

Saving a considerable amount for your retirement isn't impossible. It can be difficult, of course--especially in the early stages of a career when incomes tend to be lower. But hopefully you can afford to sock away $100 to $200 per paycheck. Though for some it may be out of reach, for others it may be more achievable than they thought.

* To find rate of return for cash, I used the compound annual growth rate of a T Bill over the period from 1928-2018 (3.4%). (A T Bill is debt instrument backed by the U.S. Treasury that has a maturity of less than one year.) I then used Bureau of Labor Statistics CPI data to come up with a compound growth rate for inflation over the same period (3.0%).

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