Your 401(k) plan can be a significant contributor toward a comfortable retirement.
However, if you don’t make the right 401(k) selections and follow the best practices, you may find it harder to retire early. In this article, we will be taking a look at tips for 401(k) investing.
Start at an Early Age
If you are ten or even five years from retirement, it still makes financial sense to invest in a 401(k) plan. Keep in mind, however, the earlier you start saving in a 401(k) plan, the more you can leverage the power of compounding interest.
To illustrate, if you earn a return of 6% per year, your money will double every 12 years. As a result, if you start investing 36 years before retirement, your initial investment can potentially double three times.
Start with Your Company’s Plan Document
If you want to start planning for retirement, start with your company’s Plan Document. This document contains all the information you need regarding the vesting schedule and company matching.
The vesting schedule outlines how long you have to remain employed before the company’s contributions to your 401(k) plan become yours. Usually, with each year of employment, you are entitled to a higher percentage of the employer match.
Study your Plan Document thoroughly to derive optimal benefit from your 401(k) investments.
Utilize Employer Match
Many 401(k) plans offer a company match, which can jump-start your savings significantly. If you work at a company that provides a match on your contributions, make sure that your contributions are high enough to maximize this benefit.
Think about it, if your employer matches dollar for dollar up to 3%, and you invest only invest 2% of your income, you are leaving 1% of your income sitting on the table. Over the lifetime of your employment, that could be more than $100,000 you could have invested.
Investing up to the employer match is one of the best saving options, and it allows your funds to grow in line with future increases in your salary. If you are not taking advantage of a company match, you a losing out on a lot of retirement savings.
Hire a Professional
Many people try to navigate through their 401(k) options on their own. However, formulating an investment strategy to meet your retirement goals can be a challenge. If you don’t understand your investment selections, their risks, hidden fees, and potential returns, seeking advice may be your best option.
Blooom is a robo-advisor that focuses on helping people with their employer sponsored retirement accounts.
Blooom will analyze your account options and make recommendations using your risk tolerance. Risk tolerance is determined using the information you provide in a 5 minute questionnaire you take when you sign up.
The free analysis allows you to see hidden investing fees, see how your funds are currently invested, and receive recommendations. The paid version is $120 a year and gives you access to expert advice, a deep dive into other potential fees you can avoid, and several areas you can get help.
Hiring a professional is a viable option regardless of whether you just started to invest in your 401(k) or have had one for a long time. Consult with an experienced professional and have them review your options and 401(k) plan.
If you are starting your career and setting up a household, chances are you can’t afford significant contributions to your 401(k) plan. Start by making small contributions that you ramp up every time you receive a raise. Even a $100 investment gets you started and interest building.
You don’t have to pour your entire raise into your 401(k) investment. Instead, plan on increasing your contribution by one or two percentage points so you can still enjoy your raise.
One of the most important secrets to successful investing is to avoid making lifestyle upgrades every time you get an increase and to focus on your 401(k) contributions.
Complete the Beneficiary Designation Form
In the event of your death, the beneficiary designation form determines who receives your 401(k) funds. Many people forget about keeping this form up-to-date when they remarry or have children.
For example, if you don’t want your 401(k) to go to an ex-spouse, don’t forget about the beneficiary designation form.
Consider Your 401(k) Selection Options
With your enrollment packet, you will receive a brochure including information on all your 401(k) selection options. Consider these investment options carefully, so you know where your assets are allocated.
The informational materials you will receive from your plan manager may promote target-date funds with predetermined investment mixes. To ensure that your 401(k) is invested in bonds and markets that will provide the growth you need, ignore target-date funds, and focus on individual funds.
If you are not sure which options are the best investments, consult with an outside professional to help you select your 401(k) investments.
Make Catch-up Contributions
Your contributions don’t have to stop at the company match, however. In 2019, you can sock away up to $19,000. Note that if you are 50 or older, you have a catch-up contribution option with a limit of $6,000.
You may have to live below your means to reach these limits, but they will benefit you significantly when you retire.
Pay Attention to Company Match Timing
Your firm may be matching contributions on a pay-per-period basis. In this scenario, if you reach the IRS contribution limit early in the year, you may not be entitled to the match contribution for the remainder of that calendar year.
The company match timing descriptions are usually in the fine print. You should read your company’s 401(k) plan thoroughly—DO NOT skim through this document.
Pay Attention to Hidden Expenses
Study the informational materials and fact sheets to determine hidden expenses and see how the portfolio is constructed. The target date should also align with your personal goals.
Additionally, be careful—not all index funds are low-cost. If the fees seem high, consult with your company’s HR representative.
When compiling a portfolio of mutual funds, prioritize diversification and spread your risk across several investment types. Instead of focusing on one asset class, consider low-cost funds that meet your risk tolerance.
A diversified portfolio will typically consist of large-cap stock, small-cap stock, foreign stock, and intermediate-term bonds. If you still have a long time before retirement, you can focus more on stocks and less on bonds and cash.
Stick to Your Strategy
After building a diversified portfolio, stick to your long-term investment strategy, and don’t start buying and selling to stay on top of market conditions or out of fear.
Create an Emergency Fund
You have a 401(k) plan in place to ensure that you have money when you retire, not to take care of sudden expenses. Unfortunately, life is unpredictable, and you may need cash for unforeseen events such as unemployment, accidents, or damages.
Instead of withdrawing your retirement funds to pay unexpected expenses, set up an emergency fund to cover mishaps.
Plan on Paying Taxes
When the day comes for you to withdraw from your tax-deferred 401(k) plan, you will owe taxes on those withdrawals. For example, if you are planning on withdrawing one million dollars from your tax-deferred account, it can be unsettling to realize that you still have to pay taxes.
To minimize your tax liabilities, consider diversifying your 401(k) plan with both tax-deferred and after-tax accounts.
Rebalance Your Portfolio
Rebalancing your portfolio means buying and selling shares of your mutual funds to return your existing investment allocations to their original allocations.
Say, for example, you initially chose five mutual funds at allocations of 20% each, and after one year, one grew to 25%, one declined to 15%, and the rest stayed the same.
Rebalancing in this scenario means that you sell the shares in the fund that grew and buy shares in the fund that declined to restore the allocation of 20% per mutual fund share. Rebalancing is comparable to the process of buying low and selling high.
Retirement should be one of your primary saving goals. If you are no longer able to earn an income, you will rely heavily on your savings to live comfortably. If you are disciplined with your 401(k) plan, however, you should not have to make lifestyle downgrades.