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How Much Should I Contribute to My 401K? | 1 min money talk

What is a 401K?

Your 401K is a employer sponsored tax-advantaged account where you can invest money from your paycheck before the government has taken taxes out of it.

 

Why Should I Invest With a 401K?

Investing in a 401K is a good idea because the money gets to grow with money that would have otherwise been given to the government. Your 401K contributions also lower your taxable income, so for example if you make $50K a year but invest $5K in your 401K, you’re only taxed as making $45K a year.

 

How Much Should I Be Contributing to My 401K?

Basic wisdom says you should at least contribute enough to receive your employer match, as this is free money. So if your employer matches up to 5%, then you should at least contribute 5%.

 

Beyond that, you should try to increase it as much as possible until you reach the max contribution amount, which is $18,500 a year as of 2018.

 

That said, start with baby steps. So try to start with 5%, then each 3 or 6 months raise it a percentage. Ideally, after a few years, you’ll be at 10-20% and then a few years later you’ll be maxing it out.

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How to Become Wealthy | 1 min money talk

Becoming wealthy comes down to three things:

  1. Make more money
  2. Spend less money
  3. Invest the difference

 

Continually improve these three steps and you will become wealthy.

 

Step #1: Make more money

You need to get a raise at work, find a new job, take on a second job, start a business or side hustle. Get your hands on more money. You won’t get rich making minimum wage even if you crush the next two steps.

 

Step #2: Spend less money

If you become an income-machine but spend it all, you will never get rich. You have to not only make more money, but keep it so you can invest it. Eat ramen and beans for all I care, just don’t blow all your earnings.

 

Step #3: Invest the difference

Becoming wealthy is all about widening the gap between how much money you make and save, but then investing that extra money. You need to invest it and make a return on your money. This can be in the stock market, real estate, your business. Investing is about owning an asset that grows in value over time.

 

These are the three steps and they all work together. You have to improve all three if you want to become wealthy.

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Charlie Munger: Why the First $100K is the Toughest

The Wise Charlie Munger:

 

At a Berkshire Hathaway shareholder meeting in the 90’s, a young guy asked Charlie Munger his advice on creating wealth. He said his net worth was not increasing as fast as he’d like.

Charlie Munger responded, “The first 100,000 is tough, but you gotta do it.”

Then he goes on to say, “I don’t care what you have to do—if it means walking everywhere and not eating anything that wasn’t purchased with a coupon, find a way to get your hands on $100,000. After that, you can ease off the gas a little bit.”

 

Chasing Your First $100K:

 

I’m also chasing my first $100K and can definitely say it’s tough. I say it’s tough, but in reality it’s probably tougher because of my lack of patience rather than the actual difficulty. Especially after developing good habits around saving, earning and investing.

So why does $100K feel so far away? Why does it feel like it’ll take forever?

Because when you don’t have much money, the majority of increases in your net worth come from your savings rate, not investment returns, so your money isn’t working for you as much.

 

Here’s an example to help explain the numbers:

 

Let’s say your net worth is $10,000, and it’s all invested in the stock market. If you have a healthy return of 10% that year,  you’ve gained $1,000 increase in net worth.

Ultimately, $1,000 gain is not much.

However, if you get a roommate and your rent lowers by $300 a month, you’ll save $3,600 a year.

$3,600 savings is a 36% increase in your net worth.

And if you can get a $5K raise, that’s a 50% increase in net worth.

 

Savings Rate > Investment Returns (In the Beginning):

 

In the beginning, when you’re trying to reach $100K quickly, you need to do whatever you can to spend less and earn more, because your savings rate is much more important than investment returns.

While a lot of people focus on their investment returns, this effort usually doesn’t pay off until you’ve accumulated a good amount of wealth.

In the meantime, saving a few hundred a month on rent or buying a used car with cash, can mean huge relative increases to your net worth that will beat the market every time.

While reaching $100K seems difficult, the journey will teach you good saving habits that will propel you through the next tough challenge – taking $100K to $1M.