The 401(k) Millionaire
Villard/Random House, 1998
"A wise man will make many more opportunities than he finds." -
Francis Bacon
Chapter One: How I Became A 401(k) Millionaire

Back in the mid-1950s, when I was just starting out in business, I was a big spender. I only dabbled in investing. Like many other carefree bachelors, I had to marry a good woman before I set my priorities straight. It was time to deep-six my bachelor mentality and create a budget so I knew where our money was going. My wife Pat and I both wanted a family and a nice house, and we knew we wanted to save for long-term goals, like college for our kids and a nice retirement for us. Keeping track of your dollars and cents is the first step to becoming a 401(k) millionaire; it’s the bedrock on which everything else rests.

Once you record your monthly expenses and compare that with your monthly pay, you can adjust your style of living accordingly. And the earlier you do it the better. If you don’t pinch pennies in the beginning, you’re squandering a golden opportunity to make more money down the road. It’s what economists call "compound interest" - that’s when you earn interest not only on your original investment, but also on the interest it has already earned. Through compounding, your investment assets grow, slowly at first, then at greater speeds as the years go by. I can’t emphasize enough the importance of compound interest. It’s the fuel that your makes your 401(k) run.

Consider a monthly investment of $300. Given a 9% rate of return, that $300 monthly investment turns into $22,627 after five years; $58,054 after 10 years, $200,366 after 20 years, and an astounding $336,337 after 25 years. In fact, the longer you leave it alone the more the interest "compounds." No wonder Albert Einstein referred to compounding as the most remarkable mathematical discovery ever! Economists may have a dry, bureaucratic name for it, but I prefer calling compound interest your very own personal money-making machine.

Back to the budget for a moment. Now, I know what you’re thinking: Patricia and I lived on scraps of bread and dressed in rags so that we could save enough to retire as millionaires. Pardon my French, but that’s baloney. We simply developed a sensible financial plan that enabled us to save money without depriving ourselves of the occasional John Wayne movie or night out on the town. In fact, I don't recall being deprived of anything in those early years. All I remember is that before setting up a budget I had a hard time making it from paycheck to paycheck. After the budget, it seemed like we had extra money. Even to this day, though I can well afford it, I have never bought a new car. I’ll look around for a low mileage, two-year-old car and let someone else take the depreciation.

At first we only put away what we could each month. Another night at home instead of dining out, a few degrees lower on the oil heater, and other household cutbacks gave us an extra $10 or $20 a month. Before long, we were putting even more away-$30, $40, and even $50 a month! Believe me, that was big money back in 1960.

To make the most of the extra money we were saving, I joined an investment club shortly after starting our budget. Once a month after work, I met with about six other like-minded savers who’d gotten together to take advantage of the growing attraction of the stock market. There I learned the importance of teamwork and taking responsibility for your financial future. Each month one club member would handle the research and recommend stocks to the group, who collectively gave the proposals a thumbs-up or thumbs-down. I noticed that the club members who had done their homework the best were the ones whose ideas received the most favorable responses. Thus, an avid research hound was born. To this day I read as much as I can about the financial markets, and it’s been an immense factor in helping my family reach our financial goals.

At the investment club I learned another key financial lesson: diversify. At the time my company, Hooker Chemical, was struggling financially. The company’s stock was floundering as well, and me along with it. I owned a bunch of shares myself, as did the investment club, and we all took a financial bath as the stock headed south. Any investment portfolio should be able to weather the demise of one stock, unless it’s a stock that comprises a hefty part of your portfolio. We’d learned that lesson the hard way, and it stayed with us the rest of our lives. Always diversify your investments so that you’re not too reliant on one stock, one bond, or one mutual fund. Believe me, if it collapses in a hurry, you can too. By allocating a mix of stocks, bonds, and mutual funds in your portfolio, you can minimize losses in one area and even make it up simultaneously in another area.

After I left Hooker Chemical and moved to Louisville, Kentucky, to take a job at another chemical company, I shifted my financial plan into second gear. I shed the bad habit of being a frequent trader in favor of a buy-and-hold investment viewpoint: buying a stock or a fund and hanging onto it for a long time. As a "day-trader" (one who buys a stock in the morning and hopes to sell it the same afternoon for a profit), all I’d been doing was making my broker rich. I remember calculating that over 70% of the stock selections I was making at the time were money-makers. But the bottom line showed me losing money because of the sorry performance of two big stocks I held and the hefty commissions I was paying my broker for all the trades I was making. After three years I figured I had broken even and my broker had made $20,000 off of me while I took all the risk.

In addition to hanging onto stocks longer, I also began paying attention to things like company balance sheets and price-earnings (P/E) ratios. By taking a more active role in the companies I was investing in, and spending a half-hour on the train each morning reading about the companies, I learned to invest in the company and not the stock, another lesson that still rings true. I also adopted the Peter Lynch (the famed original portfolio manager of Fidelity Investment’s Magellan Mutual Fund, the biggest fund in the world) approach to picking companies. Lynch would walk through malls and see which stores were crowded and what products customers were buying. Taking a page out of the Lynch handbook (and then some) I’d ring up the customer service center and find out how committed the company was in satisfying customers and whether or not they stood firmly behind their product.

I also began to recognize the wisdom of investing in mutual funds and the risk of investing in individual stocks. In those years, I considered my stock investments as my potential big-ticket, home-run-type investments and my mutual funds as a savings-account-oriented afterthought. Lo and behold, my financial statements began telling an interesting story: my funds - which I never touched - were making more and more money each month while my stocks - which I traded frequently - lost $2,000 over the course of several years.

By the 1970’s, I had left the chemical company in Louisville and switched to a career in sales. The increased demands of my new job made it more difficult to track company and industry research. Thus, I adopted an ill-advised investment strategy called "market-timing" to handle my stock investments (market timers attempt to guess the peaks and valleys of the stock market and invest accordingly). A few specialized newsletters and financial services companies claimed they could plot the timing signals for me, but you could just as easily catch a hummingbird in your hands as you could forecast the intricate patterns of the financial markets. Another lesson learned too late, as the market-timers repeatedly guessed wrong and again my investment portfolio suffered.

Fortunately I found a silver lining in my market-timing years that led me into the world of the 401(k). In the early 1970’s the U.S. government gave the green-light to the first Individual Retirement Account, a tax-advantaged plan that enabled Americans to sock up to $1,500 per year away tax-free (that number was raised to $2,000 several years later and to $2,250 by 1990. During the stock market decline of 1973, I lost a lot of money on stocks that I would never make back again. But the mutual funds in my IRA kept my retirement portfolio on an even keel, as I kept pouring money into it during good times and bad. Another lesson learned: the value of dollar cost averaging.

IRA’s also served another valuable purpose: they taught me the increasing value of making an investment plan and sticking to it like carpenter’s glue for 20, 30, or 40 years. With IRA’s, I wasn’t swayed by short-term market swings. For years, my eyes would be riveted to stock listings in the Wall Street Journal. Stock gyrations of a couple of points or so were cause for either great satisfaction or considerable consternation in the Iwaszko household on a daily basis. Or, if I saw a mutual fund that doubled its money in a year, while mine returned only 25%, I’d grow very frustrated. Nobody wants to go through life like that. My IRA taught me the common-sense value of a long-term investment approach and afforded me a new outlook on my investments: patience. Now I think that the certainty of money over the long haul with minimal risk, as opposed to potentially grabbing a dollar or two more while losing sleep at night, is a no-brainer.

More secure in my investment philosophy, I was now ready to embark on the last, most crucial step of my journey to becoming a 401(k) millionaire. I went to work for my last full-time employer in 1980, just about the time the U.S. government and the IRS were approving the first 401(k) plans. I couldn’t believe my ears when the human resources staffer at my new company was explaining my 401(k) to me. I’ve always said that maxing out on your retirement plans was like winning the lottery, and with 401(k)’s, it was easy to see why. With my first 401(k) I could put away 6% of my salary and my company would match 3% of my money from their own pocket. That meant if I stashed away $4,000 in my 401(k), my company was basically handing me a check for $2,000 with only one caveat: the money had to go toward my 401(k) plan. So even if my 401(k) investments made no money (and they almost always did) I was making a bushel of cash on my own, courtesy of my employer.

Even though I was out on the road a lot as a salesman for my new company, I made it a point to try to research as many of the funds available to me in my 401(k) plan as I could. In the early days, that wasn’t so tough. Back then there was usually a limited menu that included a stock fund, a money market fund, a bond fund, and shares in company stock. Even with fewer investment choices than the 20 or 30 fund investment options many company 401(k)’s offer today, that didn’t stop me from formulating a simple investment model to serve as the cornerstone of my 401(k) success.

Part of that plan, as I said earlier, was sticking to mutual funds, especially no-load ones that didn’t charge me high expenses. I liked the professional management that funds offered. I also liked the fact that fund companies were skilled marketers and placed a high premium on satisfying people like you and me. Thus, I could call the fund company 24 hours a day and get an answer if I needed one. I especially liked the fact that no-load mutual funds weren’t shilled by pushy stockbrokers (admittedly an eyebrow-raising comment from a fellow salesman, but an accurate one just the same). One fact I’ve always liked about no-load mutual funds is that they sell themselves: they fit a category, like growth funds or municipal bond funds, that fill your investment needs, and you could check their track record in the paper just as easily as you could follow Ken Griffey Jr.’s batting average.

Mutual funds were simply the means to an end: investment vehicles that would carry my money along to retirement. Charting the course that would take me to retirement with a million dollars, however, was a different story. That required a more substantial investment model, one that I created and fine-tuned over the years and that ultimately helped make me a 401(k) millionaire. And in this book, I’m ready to share it with you.

My investment philosophy is simple. So simple, in fact, that its basic tenets can fit onto an index card you could hold in the palm of your hand (which isn’t a bad idea). My five-point plan is built on the idea that where you invest your money isn’t as important as how early and often you invest your money. Learn these rules and you, too can join the growing ranks of the 401(k) millionaires:

<CHAPTER 1, CHART #1>

Knute’s Five Rules for Investment Success

1. Start Early. There’s no substitute for getting a good start on your financial future. All the studies on the subject conclude that the earlier you get going with your 401(k), the more money you’ll have in retirement. That’s because the earlier you start, the earlier compound interest goes to work for you.

2. Max Out. 401(k)’s provide a multitude of benefits for investors. One of the most beneficial is the plan’s tax-advantaged status. In short, the more you contribute to your 401(k) plan every year, the less you’ll pay in taxes to Uncle Sam. Then there’s the obvious advantage of maxing out and investing the legal limit in your 401(k). The more money you invest, the more your company might match, and the faster you’ll become a 401(k) millionaire.

3. Learning is Earning. The value of good investment research is priceless. And the value of knowing enough about your 401(k) to become the master of your financial future is priceless. Read all you can on finance and investments, and make sure you read every word of the 401(k) packets, brochures, and memoranda that come your way from your employer each year. The payoff for spending an hour or two a week boning up on the ways of Wall Street are potentially huge, particularly as 401(k)’s are starting to expand and go global. Don’t be left behind.

4. Be Aggressive. Prudence is the proper course if you’re an airplane pilot or a brain surgeon. But it’s a drawback for 401(k) investors. Studies show that to beat inflation and to make your money grow faster, a good chunk of your plan should be earmarked for higher-performing stock funds. That doesn’t mean you should be reckless. There’s no rule that says you have to put money into Portuguese debentures because your buddy in accounting did. But if you stick to conservative investments like bonds or, worse, bank savings accounts, your chances of becoming a 401(k) millionaire are virtually nil.

5. Keep the Money Working. Over the years I participated in other profit-sharing plans. When I left those companies, I was given the option of taking the cash and rolling it over into another tax-deferred investment plan like a 401(k) or IRA or taking the money in a lump sum and using it as I wished. The latter is a bad move and here’s why: the government wants you to roll the money over and they’ve set up expensive traps if you don’t. The IRS can take up to 20% of your retirement plan assets away from you if you elect to take a lump sum payout when you leave a job. If that’s not grim news, consider this: they’ll also tax you on the capital gains your money has earned while participating in the plan. (When you sell an investment for more than you paid, your profit is called a capital gain. It can be taxed at a rate as high as 28% of your earnings.) I’ll cover 401(k) and IRA rollovers in chapter 3, as well as the folly of taking loans out against your 401(k). You’ll see why keeping your money working in your 401(k) isn’t just your best option, it’s your only option.

Those are my five rules for 401(k) investment success. I applied each to my own 401(k) plan early on and sat back and watched my money grow. From time to time, I’d check on my retirement portfolio, and make adjustments when I felt I needed to. But by and large, I lived by the tenets of my five rules and let the twin miracles of the stock market and compound interest take care of the rest. As I said, it would have been great if I knew how to manage my money like a pro early on. But that takes time. It really wasn’t until I retired in 1994 and sat down in my kitchen to tabulate my retirement assets that it hit me how powerfully these five rules had worked in my favor. When I saw that the final figure was well over $1 million I nearly fell out of my chair. That was a wonderful feeling and one that I want you to share. That’s what this book is all about - making sure you see seven figures when you tabulate your retirement assets.

I’ll go into more detail on my five rules of 401(k) investing throughout the book. I’ll also spend some time discussing the wisdom of allocating your assets every year so you’re investing comfortably within your risk limits and with an investment plan that makes sense for you. But first let’s start by covering the basics of the 401(k) plan: how it originated, its myriad benefits, and how it works.