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The idea of investing can be intimidating. Especially when you're young, have little savings, and know nothing about the topic.
My husband, Alan, and I started investing before we knew what we were doing. And before we were on solid financial ground.
At first, it was a bit uncomfortable, but we were motivated by “free” money and convenience.
The good news is, that it turned out to be one of the most vital financial decisions we've ever made.
Our Best Investment
We started contributing to Alan's employer's 401(k) plan in our mid-20s. Since then, we've invested in other ways too.
Still, for us, the 401(k) is the best investment decision because it's the one that got us started.
It wasn't easy to begin investing, though.
We were young, knew little about investing, and spent every dollar from each paycheck. So, at the time, it felt like we were taking a significant risk.
But, despite our fears, and thanks to some wise advice from Alan's college professor, we got started. And we've been investing in the 401(k) for over 20 years now.
We even invested during the 2008 stock market downturn.
We didn't touch the investments and kept contributing. And we were thankful we did when we later watched our investments bounce back and grow.
Of course, history isn't indicative of future events. But that experience taught us not to make rash decisions during market volatility.
Since then, experience and education have taught us more about investing.
So, we've opened other retirement accounts, like Traditional and Roth IRAs. And later, we added a brokerage account and crowdfunding to our investments.
As a result, we continued to improve our finances over the past 20+ years.
Why the 401(k) Ranks Best for Us
1. It involved “free” money.
Initially, I was hesitant to invest in the 401(k) since it would lower take-home pay. But it was the employer match that convinced me it was worth a try.
Free money is hard to pass up, and Alan's employer matched up to 6% of our 401(k) contributions.
Plus, once we started making contributions, we got used to a little less in the paycheck, and it wasn't a big deal.
2. It got us started investing relatively early.
Alan had a college professor that told his class – every time they met – to invest early and often. He repeated the advice over and over, and it took.
Alan was adamant we start investing even though it was hard to give up part of the paycheck.
We didn't think about asset allocation, risk tolerance, diversification, expense ratios, or even our goals. In other words, besides saving for the future, we didn't know what we were doing.
But investing in the 401(k) was convenient. Also, the employer contributions and limited investment choices made it less overwhelming.
3. It was automatic.
Our 401k contributions were automatically taken out of each paycheck. Since we didn't even see the money, we didn't have to decide to contribute each month – it just happened.
Plus, it wasn't convenient to change the contribution back then. So, we kept investing each month.
4. It was easy to contribute more with raises.
We contributed the minimum to get the employer 401(k)match for many years. But later, we began increasing the percentage of contributions with each annual raise.
We did this for a few years, and since we never experienced the increased pay from the raise, we didn't miss the money.
Eventually, increasing our contributions meant reaching the IRS 401(k) annual limit. By using yearly raises, this was more doable for us.
5. The tax benefits.
401(k) employee contributions are pre-tax, reducing gross income. So, this helped lower our tax bill each year.
Also, since the 401(k) grows tax-free, it's a win-win for tax benefits. (Still, we have to pay income taxes on all withdrawals later.)
The downside to the 401(k)
The main drawback of the 401(k) is that there's limited access to it before age 59½ without paying a 10% penalty (plus income taxes).
Still, there are a few ways to withdraw it before then without paying the penalty.
For example, in particular life circumstances, the IRS allows early distributions. Disability and unreimbursed medical bill expenses are a couple of instances that qualify (see the IRS website for more).
Also, a 401(k) loan is possible, but each employer has different 401(k) loan rules. You have to repay the loan with after-tax dollars plus interest, and re-payments go to your 401(k) account.
Besides those options, there are other ways to access 401(k) funds without penalty.
If you plan to retire before age 59½, you might explore the following options:
- The Rule of 55 states that you can withdraw from your current employer's 401(k) penalty-free at age 55.
- IRS Rule 72(t) allows you to take substantially equal periodic payments (SEPP) from the 401(k). But this rule is a bit nuanced and must get followed precisely to avoid penalties.
Before using any withdrawal method, it's wise to understand them fully. Or hire a financial advisor and tax professional to avoid unnecessary penalties.
Alan and I will access the 401(k) funds before age 59½. At this point, we plan to take a different approach via a rollover into a traditional IRA.
We'll then make conversions into our Roth IRA each year (and pay taxes on the conversions). Then, after five years, we'll have access to the conversions, penalty, and tax-free.
For us, the 401(k) limitations are a minor inconvenience for all the benefits. It got us started investing and helped us consistently invest for years. And that put us ahead of the curve.
Our worst investment(s)
I can't talk about our best investment without mentioning our worst!
We bought two separate homes as our primary residences when we were young and newly married.
Back then, we thought of them as an investment. And we believed renting was throwing our money away.
But there's clarity in hindsight.
If I had to do it over, I would rent instead of buy because we sold the homes within months. And that cost us thousands of dollars we would have saved if we'd rented longer.
That experience taught me to think about a primary residence as a place to live, not an investment.
We didn't know the 401(k) would be such a good investment for us when we started. In truth, we didn't give it that much thought at the time!
We invested in the 401(k) because 1) it was convenient, and 2) it involved free money.
Those two factors motivated us to start investing at a reasonably young age. And, after years of contributions, employee matching, and compound interest, it's by far the best financial decision we've made!