Key Points
- Saving for retirement early and contributing a significant amount has a greater impact on your final nest egg than chasing slightly higher investment returns.
- A recent analysis using a tale of two savers shows how starting at age 25 and saving 13% (including a company match) can result in a $1 million larger 401(k) balance than starting at 30 and saving 9%, even if the latter’s investments perform better.
- While new regulations may soon allow alternative assets like private equity in 401(k) plans to boost returns, these complex investments are not a substitute for the foundational power of long-term compounding.
- The most critical factors for a successful retirement are disciplined savings habits, not the nuances of whether your portfolio includes public or private market assets.
The Debate Over Advanced 401(k) Investments
In the world of retirement planning, a significant conversation is emerging around the types of assets available in employer-sponsored 401(k) plans. Following a recent executive order, regulators are now exploring ways to allow target-date funds and managed accounts within these plans to include alternative assets, such as private market investments. The goal is to potentially increase returns and secure better retirement outcomes for millions of Americans.
However, as the focus intensifies on complex investment vehicles, a crucial question arises: Are we overlooking the most powerful tools for building wealth? An analysis comparing two different retirement journeys suggests that the simple, timeless principles of saving early and saving consistently have a far greater impact than the specific assets you invest in.
A Tale of Two Retirement Savers
To illustrate the profound impact of savings habits, consider the story of Laura and JR, two 25-year-old colleagues starting their careers at the same company with identical $75,000 salaries.
Laura’s Strategy: Start Early, Save More
Laura, dreaming of a comfortable retirement, decided to act immediately. On her first day of work, she enrolled in her company’s 401(k) and committed to contributing 10% of her salary. Her employer offered a 50% match on contributions up to 6%, meaning she received an additional 3% from the company. In total, 13% of her salary was being invested for her future from day one.
JR’s Strategy: Delay and Depend on Higher Returns
JR, on the other hand, felt that retirement was a distant concern. He chose to enjoy his income in the present, spending on travel, dining, and entertainment. Five years later, at age 30, he decided it was time to get serious about saving. To minimize the impact on his paycheck, he contributed just enough to get the full company match—6% of his salary, which, with the 3% match, totaled a 9% savings rate.
The Investment Choice: Simplicity vs. Complexity
Both Laura and JR had access to similar target-date funds. Laura opted for a traditional fund invested solely in public stocks and bonds, appreciating its simplicity and transparency.
JR, feeling he needed to make up for his late start, was drawn to a different option: a target-date fund that allocated 15% of its portfolio to private equity and private credit. He hoped the promise of higher returns from these exclusive markets would help him quickly close the five-year gap.
The Surprising Results at Retirement
Decades later, as both Laura and JR prepared to retire at 65, they reviewed their 401(k) balances. Their careers had progressed in parallel, and they were both earning the same final salary.
JR was pleased to see that his bet on private markets had seemingly paid off. His fund delivered an impressive annualized return of 8.9% over his 35 years of investing. The traditional, public-only fund chosen by Laura returned a slightly lower 8.4%. JR’s account balance stood at approximately $2 million, a sum that gave him confidence for a secure retirement.
However, when Laura checked her balance, the small difference in investment performance was rendered insignificant. Despite the lower annualized return, her 401(k) had grown to over $3 million.
The Real Million-Dollar Difference
How did Laura end up with $1 million more? The answer lies in the fundamentals. By starting five years earlier and contributing a higher percentage of her salary, she harnessed the incredible power of compounding returns for a longer period. Her discipline and consistency did the heavy lifting, turning her steady contributions into a much larger nest egg.
The moral of this story is clear: while the allure of high-return, complex investments is strong, it is far better to focus on what you can control—how much you save and when you start. The debate over private equity’s outperformance continues, with many experts noting that median returns are often similar to public markets after fees. Behavioral tendencies, like delaying savings or anchoring contributions to the minimum match rate, are the real obstacles to a winning 401(k). For anyone planning for the future, the most impactful decision is not about chasing the whims of the market, but about committing to a disciplined savings plan today.
Image Referance: https://www.morningstar.com/portfolios/key-winning-401k
