In my last post, we went into some pretty specific details about why I feel that Dave Ramsey’s financial plan doesn’t work for high-debt young professionals. One of the big issues I have with it is that it doesn’t call for any retirement investing until after your student loans are paid off. I think this is the biggest flaw in Dave’s plan, and as much as I love his work and have been personally inspired by him, this point deserves some deeper inspection.
In my opinion, there are very few financial truths out there. For the vast majority of personal finance decisions that one may need to make throughout a lifetime, a good case can be made that there are many different right answers. What I’m about to say is one of (maybe the only) those elusive truths; a statement so profound that no good argument can be made against it. The pressure is on, but here it goes: If you work at a job in which you are eligible for a 401(k), and your company offers you a match, you absolutely, positively need to invest enough money to get the match.
There is no debate . Not even Dave can argue with it, though he may try. If anyone makes a comment below that tries to justify why it isn’t the right decision, SAID COMMENT WILL BE IMMEDIATELY DELETED BY THE MODERATOR… okay maybe that last part is a lie, but seriously; it’s a tough statement to get cross with. Let’s look at why.
What a Company Match Really Is
If you’re on this blog, you are probably ahead of the game in terms of personal finance knowledge. In case anyone doesn’t know, however, I will give a brief synopsis on what a 401(k) “match” is.
The long answer is that a 401(k) match is a way for your company to encourage you to save for retirement by agreeing to help you get there. If you have a company match of, say, 5%, this typically means that if you save 5% of your pre-tax income into your 401(k), your company will then “match” your investment and put that same amount of money in for you.
It’s not always a 1:1 match rate; maybe you’re required to save 5% to get a 4% match, or 6% to get a 3% match, but it is always quid pro quo; you get the match in exchange for making an investment of your own, as opposed to the company just giving it to you without any of your skin in the game.
Here’s an even simpler explanation of what a 401(k) match is: FREE MONEY!!!
Seriously, getting your company match is literally like getting money for free. If you want to be a stick-in-the-mud and point at that there’s no such thing as a free lunch and technically you did have to invest some of your own money and blah, blah, blah, then fine, don’t call it “free” money. Call it the best return on your money you’ll ever get.
Think about it: If you’re taking advantage of your company’s 401(k) match, you’re probably getting at a minimum a 50% return on your money. In a lot of cases you’re getting 80, 90 or even 100% returns (if it’s truly a 1:1 match). Find me one single other investment that will get you guaranteed returns like that. That’s what I thought.
Another Way to Look At the Free Money
From my perspective, there are two ways to look at the advantages of the 401(k) match. One is what we’ve just talked about; you’re basically getting a huge immediate guaranteed return on that money that you couldn’t duplicate with any other investment, including loan payments. The second way to see the match is that it actually increases your overall rate-of-return. This is definitely more debatable, but let me explain what I mean.
To calculate our investment returns, we use XIRR in a spreadsheet and learned how to do it from this awesome post by the White Coat Investor. It’s really a pretty simple formula to input once you get the hang of it, but it’s extremely powerful; it allows you to calculate your internal annual rate of return based on money flowing in and out of your accounts.
When a contribution is made to our 401(k), that contribution is recorded in our XIRR. The contribution is entered by us as a single amount. Really, though, we are recording two contributions: One that we made ourselves, and then one that was the company’s match. Our match is 5% for 4%; in other words if we invest 5% of our pre-tax income, the company will put in an additional 4% for us (oh by the way, that’s an 80% return right off the bat, guaranteed every two weeks… awesome!).
So for example, if 5% of our income for the pay-period is $500 and the company matches it with $400, our total contribution is $900. If at the end of the month we then have $945 in the account (a return of $45), our rate of return is 5% for month.
But why are we calling the company’s match (the $400) a contribution?
I mean, technically it is, but it’s not our contribution. I think a case can be made that it’s money somebody gave us for investing, otherwise known as a return on investment. In fact, I follow several good financial blogs that call the match just that, a free return, when writing something to convince you to utilize yours. When it’s time to figure your actual return up, however, they want to call the employer’s match a contribution. Wait a minute, why’s there a difference?
Do you see where I’m going with this? If we call the company’s match a return on investment, as opposed to a contribution, that changes our numbers quite a bit. In fact, that’s an understatement. Instead of having a total contribution of $900 and a return of $45, we now have a total contribution of $500 and a return of $445. All of a sudden our 5% return is an 89% return. Pretty sweet how that works, huh?!
Obviously, in the real world things aren’t that simple. I’m playing with semantics here and probably being a little facetious in my stretch of calling the 401(k) match a “return” rather than a “contribution,” (especially since we still consider it a contribution when figuring out our own rate of return with XIRR) but it’s to illustrate a point that remains the same: Whatever you call that extra money, there is no better deal in finance than getting your company’s 401(k) match.
So what are you waiting for? Forget what Dave Ramsey says, if you’re not getting your company match already, start today!
What do you think of my stance on company matches? Are you taking advantage of yours? Am I missing the point somehow? How ridiculous is it to think of the company’s money as part of your returns instead of part of your contributions? Let us know in the comments!