Financial Independence, Retire Early (FIRE) is a financial movement defined by frugality and extreme savings and investment. The most fervent FIRE devotees seek to retire decades earlier than age 65 - the traditional target retirement age - by saving up to 70% of their income annually. Most workers can’t afford a FIRE savings rate – regardless of their frugality - but any worker can have a FIRE-inspired 401(k) plan. Such a 401(k) plan can help worker affords to retire years sooner – no financial sacrifices required.
To retire as soon as possible, workers must avoid three 401(k) pitfalls throughout their working years – excessive fees, underperforming funds, and inappropriate asset allocation. By avoiding them, a worker can add hundreds of thousands of dollars to their account balance – and cut years off one’s retirement age thanks to the power of compound interest.
A FIRE-inspired 401(k) plan has three key features that can make 401(k) pitfalls easy to avoid - minimal administration fees, investments that deliver (at least) market returns, and professional investment advice. Here’s how each feature can help 401(k) participants save more annually to retire sooner.
All 401(k) providers charge plan administration fees. When these fees are paid from plan assets, the portion paid from a participant’s account reduces their investment returns dollar-for-dollar.
That’s not the worst part. Once these fees are paid out, their amount stops earning compound interest. These lost earnings can snowball into the hundreds of thousands of dollars over time. The following chart demonstrates how fees can impact a 401(k) account balance over 10, 20, 30, and 40 years assuming $20,000 in annual contributions and a 7% interest rate (compounded daily).
|
10 Years |
20 Years |
30 Years |
40 Years |
|
|
No Annual Fees |
||||
|
Account Balance |
289,660.56 |
872,926.14 |
2,047,399.97 |
4,412,341.08 |
|
Losses due to fees |
0.00 |
0.00 |
0.00 |
0.00 |
|
0.25% Annual Fee |
||||
|
Account Balance |
285,655.90 |
846,658.50 |
1,948,417.35 |
4,112,173.01 |
|
Losses due to fees |
(4,004.66) |
(26,267.64) |
(98,982.62) |
(300,168.07) |
|
0.50% Annual Fee |
||||
|
Account Balance |
281,720.92 |
821,337.63 |
1,854,935.64 |
3,834,720.26 |
|
Losses due to fees |
(7,939.64) |
(51,588.51) |
(192,464.33) |
(577,620.82) |
|
1% Annual Fee |
||||
|
Account Balance |
274,054.69 |
773,390.28 |
1,683,194.18 |
3,340,883.23 |
|
Losses due to fees |
(15,605.87) |
(99,535.86) |
(364,205.79) |
(1,071,457.85) |
|
2% Annual Fee |
||||
|
Account Balance |
259,501.47 |
687,332.41 |
1,392,682.23 |
2,555,567.65 |
|
Losses due to fees |
(30,159.09) |
(185,593.73) |
(654,717.74) |
(1,856,773.43) |
A FIRE-inspired 401(k) plan helps participants retire sooner by paying minimal administration fees. The lower the fees, the better.
With 6.5 million participants and $827.2 billion in assets, the Federal government’s Thrift Savings Plan (TSP) is our nation’s largest defined contribution retirement plan. Despite the TSP’s mammoth size, it does not use actively-managed funds to try to outperform market benchmarks (e.g., the S&P 500 index). Instead, it uses passively-managed index funds to match them. That choice can seem odd until you know that most actively-managed funds underperform “comparable” index funds (i.e., index funds with a similar benchmark.)
Fees are often the reason. Active-managed funds can cost several times more than a comparable index fund. Few have a history of offsetting their higher fees with higher returns - especially over long periods of time. The losses from these “underperforming” funds can snowball like fees over time – ultimately making retirement less affordable than necessary.
A FIRE-inspired 401(k) plan helps participants retire sooner by offering investments that deliver (at least) index fund returns.
To retire as soon as possible, 401(k) participants must maintain an appropriate asset allocation throughout their working years. This means constructing - and maintaining – an investment portfolio that balances growth potential and risk of losses. Striking this balance is important. Otherwise, a participant could miss out on gains by investing too conservatively when young or sustain unrecoverable losses by investing too aggressively when older.
To maintain an appropriate asset allocation, most 401(k) participants need professional investment advice. Fortunately, just about all 401(k) plans today offer at least one of the three basic forms - target-date funds, a financial advisor, or a “robo” advisor (i.e., algorithm-based advice). A Target-date index fund (TDIF) is usually the lowest-cost option. As such, I consider TDIF returns to be the benchmark for professional 401(k) investment advice.
A FIRE-inspired 401(k) plan helps participants retire sooner by offering a form of professional investment advice that delivers at least TDIF returns.
The priciest thing most workers will ever buy in their lifetime is retirement. Perhaps you’ve never thought of “buying” retirement, but that’s exactly what you do when you contribute to a 401(k) plan – you’re saving now to afford income in retirement. When you consider that income may need to last 10, 20, even 30 years, it’s easy to understand why retirement is not cheap.
However, a FIRE-inspired 401(k) plan can help just about any worker - afford retirement years sooner without a FIRE rate of savings. Participants just need to make small annual contributions to their account over a long period of time to let compound interest work its magic.