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Kinnel's Blueprint for a $1 Million 401(k)

Russel Kinnel
Christine Benz

Christine Benz: Hi, I'm Christine Benz for How can you amass $1 million in your 401(k)? Joining me to share some wisdom on crossing that threshold is Russ Kinnel. He is director of manager research for Morningstar, and he is also editor of Morningstar FundInvestor.

Russ, thank you for being here.

Russ Kinnel: Glad to be here.

Benz: There's been a lot of discussion recently about amassing $1 million in a 401(k). And on the one hand, you've got people saying, it's demoralizing. On the other hand, you've got people saying, well, you've got to really take big risks. You argue that people don't have to do either. They don't have to be demoralized nor do they have to take big risks.

Kinnel: That's right. You need patience. You need time. You need to let it compound. You need to hit your targets. But you don't need to take crazy risks. You can see this. There are calculators out there for a 401(k) and you can see even with a modest return assumption, you can get past $1 million. You don't need to take crazy risks--put all your money in emerging markets or put all your money in two stocks or bitcoin. No. You can do it through plain old equity and bond funds, but you do need patience and you do need a plan.

Benz: A key point you make though is, if you are earning matching contributions--and most people are on their 401(k) plans--that you should really as a first step make sure that you are maximizing that match.

Kinnel: By all means. I think you really want to get the max that you can. That starts around $18,500 right now is the max contribution in a year.

Benz: $24,500 if you are over 50.

Kinnel: Right. Right. It pops up over 50. You really want to get that because you are compounding it tax-free. But also it's a good vehicle, because it's one you really can't touch or it's difficult to touch. It's a good discipline for us. It's a good discipline because we are investing every paycheck …

Benz: Automatically.

Kinnel: … There are a lot of good things going on there. Obviously, if you are just out of college, you may not be able to hit that right away. I do think you want to strive toward that and even start contributing to it. Even if you've got student loans to pay off, you can be working on both of those, and obviously you want to make progress on both.

Benz: Right. Another point you make is to be careful with fund selection and really focus on the low-cost products. Certainly, a lot of your research over the years has pointed to the virtue of keeping costs low in terms of fund selections.

Kinnel: That's right. Some people said you have to crazy risks. I don't think that's at all true. I certainly didn't. I had a very diversified portfolio. It was all mutual funds--there's no company stock--and a bunch of mutual funds, too; it wasn't just one fund that propelled me. You want to have diversification, but you also want to have, low costs are really crucial. We don't know, the next 10 years could be a low-return environment. You really need those low costs. Again, remember, a 401(k) is a very long-running proposition. You could be in it for 40 years or more. Those low costs compound over time to a very meaningful level. Low costs are important. They also give you a little margin for error. Maybe you pick the wrong stock-picker, or you maybe leaned a little wrong way on your allocation plan. Low costs are going to help to make up that ground.

Benz: A follow-up question though is, some people are not in low-cost 401(k) plans. They might have a small employer, and that plan may in fact be high-cost. What's your advice to them?

Kinnel: Obviously then it's less appealing. If you've got to match, it's probably still worth it. Because again, if you've got a 50% return from the get go and even if you are, let's say, spending another 60 basis points above average, that's not great, but it's still worth doing. Obviously, then I think you certainly want to also keep an eye on building up your portfolio outside that 401(k). If I had a high-cost 401(k), I'm sure I'd be even more focused on low-cost outside that. I'd really be pushing the limits on really low-cost funds outside that. Generally, it's still worth it. Obviously, to the degree you can, it's worth letting management of your company know that …

Benz: It's pricey.

Kinnel: It's pricey. There are a lot of lawsuits out there, the company is at risk as well as making their employees unhappy.

Benz: One thing we've seen is that more and more index funds are appearing in 401(k) plans. So, even if they are not the cheapest of the cheap, they are usually the cheapest thing on a given 401(k) menu.

Kinnel: Index funds and institutional share classes are really growing in 401(k)s, and well-run companies are doing a good job of taking advantage of that and can really keep pushing costs lower in their 401(k) funds.

Benz: Another point that you made in the article, and you hinted at it just now, is this idea of the fact that the market environment that we've enjoyed over the past decade may not repeat itself over the next decade or so. You think patience is really important for 401(k) investors who want to try to amass a sizable sum in their accounts?

Kinnel: For sure. You may remember about 10 years ago, we were all talking about the lost decade, people in the oughts didn't really much of a return at all because you had two bear markets that looked dismal. But on either side of it, it turns out we had tremendous bull markets. The way you make money in your 401(k) is sticking to your plan through thick and thin. 

It's tough, but I think maybe the one way I could have wrecked my plan is by panicking in one of those bear markets and getting out. Because of course, you are never going to get back in at the right time. You are going to miss out. Just stick to your plan. 401(k)s have nice things like rebalancing features that will rebalance for you, which is great so that you don't let your plan get too out of balance. You really want to stick to your plan, you really want to be patient. You need to remind yourself that this is money for my retirement. This isn't money for now. This is going to work out.

Benz: I guess a related point maybe gets back to diversification, is the idea that there will always be something in your portfolio that you are sort of like, what is this here for? Like, maybe it's been bond funds for investors over the past decade, but you will be glad you have them going forward, right?

Kinnel: Exactly. That's what diversification is really about is smoothing that ride out but also the fact that calling assets is really hard. With hindsight it looks really easy, but in reality it's very hard. Right now, emerging markets look lousy, bonds look lousy, but maybe the next 10 years they will be the ones to lead. Diversification is really important not just by asset class but by fund. Spread your bets around, and that's going to work out well.

Benz: Last point, Russ, is for people who feel like they are really amassing significant sums, whether they have hit this $1 million threshold or not, you think it's important that they don't rest on their laurels. What do you mean by that?

Kinnel: The 401(k) is one piece of your investment plan. There can be many more. Obviously, investments outside your 401(k), IRAs, insurance, maybe you've got a pension. You need to look at all of that, and you need to look at your likely cost over life and see how all that works together. Either build a plan yourself or with help. 401(k) is one piece of that. If you are wealthy, you may have higher spending ambitions. You are going to need more; $1 million 401(k) sounds nice, but it actually is not the whole piece. There's obviously things like long-term care insurance, all sorts of things that you want to factor in to develop a complete plan. This is one piece of your plan. Look at it all together and adjust accordingly.

Benz: Taxes come out of $1 million. People need to set expectations on that front, too.

Kinnel: That's right. If you are 40, you know the amount in your 401(k) is going to change. It's probably going to be worth a lot more when you retire. But then you are going to pay taxes. You don't know exactly what your 401(k) is going to be worth when you retire, because there are some big changes going on. You are going to have appreciation we hope, but you are also going to have a tax bill. Factor those things in, too.

Benz: Russ. Thank you so much for being here. Always great to get your insights.

Kinnel: You're welcome.

Benz: Thanks for watching. I'm Christine Benz for