Taking Advantage of Tax-Advantaged Investing
Chances are if you are reading this blog that you are aware that 401k contributions are pre-tax which means you get to invest more now when you are working and pay fewer taxes in the long run. You also get the added benefit of that money that would lost to taxes working for you to make you more money until you actually need to use it.
These are the reasons why I believe it is in your best interest to max out your 401k contributions as your first step towards investing for FI.
Now I myself have not maxed my 401k contribution which is a problem. While I do spread a lot of after-tax money spread around to try different investment platforms to increase my knowledge and share that with people, I am also very aware of my shortcomings in my journey to FI. This is why the idea of adding 1% a month really hit home for me. Time is your biggest advantage when investing for FI so getting in as soon as possible is extremely important.
Investing Pre-Tax is Easier Than After-Tax
The human brain works in specific ways and to get to FI I need to utilize that knowledge. When it comes to money and investing, it is often easier to take the money out before it hits a bank account and you subconsciously adjust your spending to compensate, never feeling any loss for not having that money. There have been tons of studies that show this to be true for the average person. This is where the 1% increase works like a charm. How about we run some numbers:
Assume you are making $50,000 a year. After taxes, the take-home pay for my state is $3,294. Now if you decided to start bumping up your 401k by 1%. Each time you do this your monthly take-home pay would be reduced by $32. Do you think you could tighten your budget by $32? I believe I can. I had planned to greatly increase my 401k this year if I was able to get a raise however, after some reflection I think this is a poor choice. Not only is any pay raise only a possibility and not a certainty, but I expect that had I followed this plan I would have felt that I missed out by immediately dedicating that money away. By increasing 1% a month not only do I get my 401k increase but if I do manage to land a raise or promotion then I get to enjoy some of that and then slowly continue ratcheting my contributions up.
Stay Realistic
While I expect that this routine will help me to increase my investments and decrease my time to FI, I do not plan on going crazy. There will be a point where I will start feeling the crunch of increasing my contributions well before I hit the 401k contribution limit of $19,500 for 2020 and at that point, I will suspend this program and evaluate where I am. I do think that the smaller incremental changes coupled with the advantages of the pre-tax investing can help everyone, myself included, to reach even higher rates of investing.
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