401k compound interest vs other compound interest
A 401K (pre-tax or Roth) account or an IRA (Deductible or Roth) account is a retirement account. Which means you delay paying taxes now on your deposits, or you avoid paying taxes on your earnings later.  But a retirement account doesn't  perform any different than any other account year-to-year. Being a retirement account doesn't  dictate a type of investment. You can invest in a certificate of deposit that is guaranteed to make x% this year; or you can invest in stocks, bonds, mutual funds that infest in stocks or bonds. Those stocks and bonds can be growth focused, or income focused; they can be from large companies or small companies; US companies or international companies. Or whatever mix you want. The graph in your question shows that if you invest early in your adulthood, and keep investing, and you make the average return you should make more money than starting later. But a couple of notes:  So to your exact questions: An S&P 500 investment should perform exactly the same this year if it is in a 401K, IRA, or taxable account With a few exceptions:  Yes any investment can lose money. The last 6 months have been volatile and the last month and a half especially so. A retirement account isn't any different. An investment in mutual fund X in a retirement account is just as depressed a one in the same fund but from a taxable account. Growth in a 401k dodges taxes, which means more of the gains get reinvested. Effectively, it's a boosted return rate. Like any investment, a 401k can lose value. During the period before retirement, lower stock and bond prices actually help you buy more shares than you could if prices were high, so the real question is what the funds are doing at the time you start pulling money back out. That concern is why investors generally, not just 401k investors, should change their investment mix over time, to balance oossible risk against time to recover and possible reward.  And if your employer matches 401k contributions to any degree, that too improves your effective gains and buffers you against some of ghe risk. Hence the general advice that if you don't fund your 401k at least enough to max out the company match, you're leaving free money on the table. 1a. It isn't. Compound interest is compound interest. It works no different within a 401(k). 1b. Yes. 401(k)'s are made up of the same underlying assets that you could invest in with a regular brokerage account.
It would be bad tax-wise, because gains in the investment outside the 401k are taxed; whereas gains in the investment inside the 401k are not taxed. The math works out so that the 401k is still a better deal in the long term over a taxable account because of the tax-deferred growth. Let's assume you invest in an S&P 500 index fund in either a taxable investment account or a 401k and the difference in fees is .5%. I used an online calculator and a hypothetical 1k/year investment over 30 years with 4.5% tax-deferred growth vs 5% taxable and a 25% tax bracket. After 30 years the tax-deferred 401k account will have $67k and the taxable account will have $58k. The math isn't perfect -- I'm sure I'm missing some intricacies with dividends/capital gains distributions and that you'll then pay income tax on the 401k upon retirement as you drawn down, but it still seems pretty clear that the 401k will win in the long run, especially if you invest more than the 1k/year used in my example. But yeah, .84% expenses on an index fund is robbery. Can you bring that to the attention of the HR department? Maybe they'll want to look for a lower-fee provider and it's in their best interest too, if they also participate. This situation, wanting desperately to have access to an investment vehicle in a 401K, but it not being available reminds me of two suggestions some make regarding retirement investing: This allows you the maximum flexibility in your retirement investing.  I have never, in almost 30 years of 401K investing, seen a pure cash investment, is was always something that was at its core very short term bonds. The exception is one company that once you had a few thousand in the 401K, you could transfer it to a brokerage account. I have no idea if there was a way to invest in a money market fund via the brokerage, but I guess it was possible. You may have to look and see if the company running the 401K has other investment options that your employer didn't select. Or you will have to see if other 401K custodians have these types of investments. Then push for changes next year. Regarding external IRA/Roth IRA: You can buy a CD with FDIC protection from funds in an IRA/Roth IRA. My credit union with NCUA protection currently has CDs and even bump up CDs, minimum balance is $500, and the periods are from 6 months to 3 years. There's a cool calculator at Money Chimp that lets you plug in a start and end year and see what the compound annual growth rate of the S&P 500.  The default date range of 1871 through 2010 gives a rate of 8.92% for example. Something you need to take into account when comparing returns to a whole life policy is what happens to the cash value in your policy when you die.  Many of these policies are written so that your beneficiaries only get the face value of the policy, and the insurance company keeps the cash value. "If you mean, If I invest, say, $1000 in a stock that is growing at 5% per year, versus investing $1000 in an account that pays compound interest of 5% per year, how does the amount I have after 5 years compare? Then the answer is, They would be exactly the same.  As Kent Anderson says, ""compound interest"" simply means that as you accumulate interest, that for the next interest cycle, the amount that they pay interest on is based on the previous cycle balance PLUS the interest. For example, suppose you invest $1000 at 5% interest compounded annually. After one year you get 5% of $1000, or $50. You now have $1050. At the end of the second year, you get 5% of $1050 -- not 5% of the original $1000 -- or $52.50, so you now have $1102.50. Etc. Stocks tend to grow in the same way. But here's the big difference: If you get an interest-bearing account, the bank or investment company guarantees the interest rate. Unless they go bankrupt, you WILL get that percentage interest. But there is absolutely no guarantee when you buy stock. It may go up 5% this year, up 4% next year, and down 3% the year after. The company makes no promises about how much growth the stock will show. It may show a loss. It all depends on how well the company does." "This is the infographic from the Fidelity. It exemplifies what's wrong with the financial industry, and the sad state of innumeracy that we are in.   To be clear, Fidelity treats the 401(k) correctly, although the assumption that the withdrawals are all at a marginal 28% is a poor one. The Roth side, they assume the $5000 goes in at a zero tax rate. This is nonsense, as Elaine can't deposit $5000, she has to pay tax first, no? She'd deposit $3600, and would have the identical $27,404 at withdrawal time.  And this is pure nonsense -  ""Let’s look at the numbers another way. Tom takes the $1,400 he saved   in taxes from his $5,000 pretax contributions, and invests that money   in a taxable brokerage account. That could boost his total at age 75   to $35,445."" The $1400 saved is in his 401(k) already, there's no extra $1400. $5000 went in pretax.  Let me go one more step, and explain what I think Joe meant in his comment below - tax table first -   At retirement, say a couple has exactly $168,850 of income. With the $20K in standard deduction and exemptions, they are right at the top of the 25% bracket.  And have a federal tax bill of $28,925. Overall, an effective rate of 17%.  Of course this is a blend from 0%-25%, and I maintain that if some money could have gone in post tax while in the 10%/15% brackets, that would be great, but in the end, if it all skims off at 25%, and comes out at an effective 17%, that's not too bad.  The article is incorrect. Misleading. And offends any of us that have any respect for numbers. And the fact that the article claim that ""87% found this helpful"" just makes me... sad.  I've said it elsewhere, and will repeat, there are not just two points in time. The ability to convert Traditional 401(k) to Roth 401(k), and if in IRAs, not just convert, but also recharacterize, opens up other possibilities. It's worth a bit of attention and ongoing paperwork to minimize your lifetime tax bill. Time makes no difference. There is no ""crossover point"" as with other financial decisions. For this illustration, the results are identical regardless of time.  By the way, in today's dollars, it would take $4M pretax to produce an annual withdrawal of $160K. This number is about top 2-3%. The 90%ers need not worry about saving their way to a higher tax bracket." "Early this year I wrote an article Are you 401(k)o’ed?  I described the data from a 401(k) expense survey and the punchline was that the average large retirement plan (over 1000 participants) expense was 1.08%, and for smaller plans it rose to 1.24%.  As I commented below, if one's goal is to make deposits with income that avoid a tax of 25%, and hope to withdraw it at retirement at 15%, it doesn't take long for a 1% fee to completely negate the benefit of pretax savings.  These numbers are averages, in the same article, I mention (ok, I brag) that my company plan has an S&P fund that costs .05%. That's 1% over 20 years.  The sound bite of ""deposit to the match"" needs to be followed by ""depending on the choice of investments and their expenses"" within the 401(k).  Every answer here has added excellent points, fennec's last sentence shouldn't be ignored, there's a phaseout for IRA deductibility, and another for Roth eligibility. For Married filing joint, IRA deduction starts to be lost at $92K, and Roth deposit disallowed at $173K. This adds a bit to the complexity of the decision, but doesn't change the implication of the 1%+ 401(k) fees." "Often in life we have to choose the lesser of evils.  Whole Life as an investment vs. Term Life and invest the difference is one of these times. I assume the following statement is true. ""The commissions on whole life are sick. The selling agent gets upward of 90% of your first year's premium."" But how does that compare to investing in mutual funds (as one alternative)?   Well according to Vanguard the average mutual fund keeps 60% of the total returns over the average investors lifetime. And of course income taxes (on withdrawal) consume another 30% (or more) of the dollars you withdraw (from a tax deferred retirement plan like a 401k.) http://www.fool.com/School/MutualFunds/Performance/Record.htm So you have to pick your poison and make the choice that fits your view of the future. Personally I don't believe my cost of living in retirement will be radically lower than my cost of living while working. Additionally I believe income tax rates will be higher in the future than the in the present and so deferring taxes (like a 401k) doesn't make sense to me.  (In 1980 a 401k made sense when the average 401k participant was paying over 50% in federal income tax and also got a pension.) So paying 90% of my first year's premium rather than 60% of my gains over my lifetime seems acceptable.  And borrowing tax free against my life insurance once retired (with no intention of paying it back) will, I believe, provide greater income than a 401k could." First, you need to understand the difference in discussing types of investments and types of accounts. Certificate of Deposits (CDs), money market accounts, mutual funds, and stocks are all examples of types of investments. 401(k), IRA, Roth IRA, and taxable accounts are all examples of types of accounts. In general, those are separate decisions to make.  You can invest in any type of investment inside any type of account.  So your question really has two different parts:   Tax-advantaged retirement accounts vs. Standard taxable accounts FDIC-insured CDs vs. at-risk investments (such as stock mutual funds) Retirement accounts are special accounts allowed by the federal government that allow you to delay (or, in some cases, completely avoid) paying taxes on your investment.  The trade-off for these accounts is that, in general, you cannot access any of the money that you put into these accounts until you get to retirement age without paying a steep penalty.  These accounts exist to encourage citizens to save for their own retirement.  Examples of retirement accounts include 401(k) and IRAs. Standard taxable accounts have no tax advantages, but no restrictions, either.  You can put money in and take money out whenever you like.  However, anything that your investment earns is taxable each year. Inside any of these accounts, you can invest in FDIC-insured bank accounts, such as savings accounts or CDs, or you can invest in any number of non-insured investments, including money market accounts, bonds, mutual funds, stocks, precious metals, etc. Something you need to understand about investing in general is that your potential returns are directly related to the amount of risk that you take on.  Investing in an insured investment, which is guaranteed by the government to never lose its value, will result in the lowest potential investment returns that you can get. Interest-bearing savings accounts are currently paying less than 1% interest.  A CD will get you a slightly higher interest rate in exchange for you agreeing not to withdraw your money for a period of time. However, it takes a long time for your investments to grow with these investments.  If you are earning 1%, it takes 72 years for your investment to double. If you are willing to take some risk, you can earn much more with your investments.  Bonds are often considered quite safe; with a bond, you loan money to a government or corporation, and they pay you back with interest.  The risk comes from the possibility that the government or corporation won't pay you back, so it is important to choose a bond from an entity that you trust. Stocks are shares in for-profit companies.  Your potential investment gain is unlimited, but it is risky, as stocks can go down in value, and companies can close.  However, it is important to note that if you take the largest 500 stocks together (S&P 500), the average value has consistently gone up over the long term.  In the last 35 years, this average value has gone up about 11%.  At this rate, your investment would double in less than 7 years. To avoid the risk of picking a losing stock, you can invest in a mutual fund, which is a collection of stocks, bonds, or other investments.  The idea is that you can, with one investment, invest in many stocks, essentially earning the average performance of all the stocks.  There is still risk, as the market can be down as a whole, but you are insulated from any one stock being bad because you are diversified. If you are investing for something in the long-term future, such as retirement, stock mutual funds provide a good rate of return at an acceptably-low level of risk, in my opinion. "401k plans are required to not discriminate against the non-HCE participants, and one way they achieve this is by limiting the percentage of wages that HCEs can contribute to the plan to the average annual percentage contribution by the non-HCE participants or 3% whichever is higher.  If most non-HCE employees contribute only 3% (usually to capture the employer match but no more),  then the HCEs are stuck with 3%. However, be aware that in companies that award year-end bonuses to all employees, many non-HCEs contribute part of their bonuses to their 401k plans, and so the average annual percentage can rise above 3% at the end of year. Some payroll offices have been known to ask all those who have not already maxed out their 401k contribution  for the year (yes, it is possible to do this even while contributing only 3% if you are not just a HCE but a VHCE) whether they want to contribute the usual 3%, or a higher percentage, or to contribute the maximum possible under the nondiscrimination rules. So, you might be able to contribute more than 3% if the non-HCEs put in more money at the end of the year. With regard to NQSPs, you pretty much have their properties pegged correctly. That money is considered to be deferred compensation and so you pay taxes on it only when you receive it upon leaving employment. The company also gets to deduct it as a business expense when the money is paid out, and as you said, it is not money that is segregated as a 401k plan is. On the other hand, you have earned the money already: it is just that the company is ""holding"" it for you. Is it paying you interest on the money (accumulating in the NQSP, not paid out in cash or taxable income to you)?  Would it be better to just take the money right now, pay taxes on it, and invest it yourself? Some deferred compensation plans work as follows. The deferred compensation is given to you as a loan in the year it is  earned, and you pay only interest on the principal each year. Since  the money is a loan, there is no tax of any kind due on the money when you receive it. Now you can invest the proceeds of this loan and hopefully earn enough to cover the interest  payments due. (The interest you pay is deductible on Schedule A as an Investment Interest Expense).  When employment ceases,  you repay the loan to the company as a lump sum or in five or ten annual installments, whatever was agreed to, while the company pays you your deferred compensation less taxes withheld. The net effect is that you pay the company the  taxes due on the money, and the company sends this on to the various tax authorities as money withheld from wages paid.  The advantage is that you do not need to worry  about what happens to your money if the company fails; you have received it up front.  Yes, you have to pay the loan principal to the company but the company also owes you exactly that much money as unpaid wages. In the best of all worlds, things will proceed smoothly, but if not, it is better to be in this Mexican standoff rather than standing in line in bankruptcy court and hoping to get pennies on the dollar for your work." It appears from your description that the 401k account has the automatic dividend reinvestment policy, and that the end result is exactly the same as the external account with the same policy. I.e.: no difference, the dividend affected the 401k account in exactly the same way it affected the external account. The only thing is that for external account you can take the dividend distribution, while for 401k you cannot - it is reinvested automatically. Were you expecting something else? "401(k) doesn't have a ""return rate"", because 401(k) is not a type of investment -- it is a vehicle for investment, with certain tax treatments. Just like your money that's not in a 401(k), you can invest it in either the bank, a CD, stocks, mutual funds, bonds, etc., you can similarly (depending on the options given to you by your 401(k) plan) invest the money in the 401(k) in a cash account, buy stocks, mutual funds, etc. Your return is dependent on how you invest your money, not whether it's in a 401(k) or not. Whether it's in a (Roth or Traditional) 401(k) simply affects when and how it gets taxed. (It is true that most 401(k) plans offer little variety in types of investments you can choose; however, this is not a big deal, as chances are that in a few years, you will leave your company, at which point you are able to rollover the 401(k) into an IRA, at which point you will have many, many options for how to invest it.) To make a valid comparison, you should be comparing the same type of investment in both cases. That means, you should assume the same return for both the money outside the 401(k), and the money inside the 401(k), and only consider the taxes and penalties (if you plan to withdraw early)." "If the difference in performance is worth it, consider ""borrowing"" from your 401k to put into the Roth.  You pay it back, but you can stretch it out over time, and the interest charged is actually yours, because you borrowed from yourself. But you can only borrow half of the account and you have to pay it back before you can do another loan." You might be confusing two different things. An advantage of investing over a long term is the compounding of returns.  Those returns can be interest, dividends, or capital gains.  The mix between them depends on what you invest it and how you invest in it.  This advantage applies whether your investment is in a taxable brokerage account or in a tax-advantaged 401K or IRA.  So, start investing early so that you have longer for this compounding of returns to happen. The second thing is the tax deferral you get from 401(k) or IRAs.  If you invest in a ordinary taxable account, then you have to pay taxes on your interest and dividends for the year in which they occur.  You also have to pay taxes on any capital gains which you realize during the year.  These yearly tax payments are then money that you don't get the benefit of compounding on.  With 401(k) and IRAs, you don't have to pay taxes during these intermediate years. "You need to hope that a fund exists targeting the particular market segment you are interested in. For example, searching for ""cloud computing ETF"" throws up one result. You'd then need to read all the details of how it invests to figure out if that really matches up with what you want - there'll always be various trade-offs the fund manager has to make. For example, with this fund, one warning is that this ETF makes allocations to larger firms that are involved in the   cloud computing space but derive the majority of their revenues from   other operations Bear in mind that today's stock prices might have already priced in a lot of future growth in the sector. So you might only make money if the sector exceeds that predicted growth level (and vice versa, if it grows, but not that fast, you could lose money). If the sector grows exactly as predicted, stock prices might stay flat, though you'd still make a bit of money if they pay dividends. Also, note that the expense ratios for specialist funds like this are often quite a bit higher than for ""general market"" funds. They are also likely to be traded less frequently, which will increase the ""bid-ask"" spread - i.e. the cost of buying into and getting out of these funds will be higher."