How to Make the Most of Your 401K
Most of us have a 401k account with our employer. But there are people who've decided not to participate in their employer's retirement program for a variety of reasons. Some employees feel that they simply don't have the funds to sock away, and make this an excuse to skip out on the free money that comes along with company matched 401k or 403b contributions. Others would prefer to defer saving for the long term until they're "older." Others are still at the point of worrying about which high interest savings account to house their emergency funds in.
But imagine the money you're missing out on when you decide not to invest in an employee retirement program! The irony here is that the younger you do save for the long term, the better your investment returns will be over time. I started investing at the age of 23 and that was exactly two decades ago. I've been pretty happy about having made my retirement a financial priority, along with the commitment I took to building my retirement fund at a young age. Even with the volatility in the stock market, the returns have been good.
I've also heard another excuse that employees use to avoid putting money in an employer sponsored account. It's that they don't trust their employer with their money. With the nation just getting out off a painful recession, a lot of people have been concerned about the financial health of their employers — what with layoffs and all. After all, bankruptcy did Enron in, costing a lot of people their retirement years. But these fears are unfounded if people familiarize themselves with their employee sponsored plans. Here are a few tips to to help you get the most out of your 401k account.
1. Understand the rules that affect your 401k.
Don't forget that your 401k is your responsibility and nobody else's to manage. There is an administrator that handles the paperwork and provides you with a menu of investment products to choose from, but ultimately, you are responsible for the money you decide to invest. If you make the wrong choices for your investments, you can end up with a poorly performing portfolio. Realize, too, that your 401k has tax benefits and it's good to know how to leverage those benefits when you invest: for instance, avoid sheltering tax-friendly investments in your retirement plan as the tax benefits are redundant. Instead, buy tax-friendly investments in your regular accounts (such as tax exempt bonds) while you keep other assets in your 401k plan. Strategies like this can give you an edge with your portfolio.
2. Diversify your investments, even those in retirement accounts.
So your retirement accounts contain long term investments, but this doesn't mean that you should take unnecessary risks and that you should be overly aggressive with your investment selections. Use the investment tools offered by online brokers and investing sites to check on your portfolio's composition and how to best diversify your contributions.
3. Know the best investments for retirement accounts.
There are certain investments that may be more suitable for long term accounts and which work best with a 401k. Stock mutual funds and index funds are great choices — they are the perfect balance of risk and reward, in my opinion. It's also interesting to note that many employers will offer their own stock as part of their company retirement program. Should you invest in your employer's stock? It's up to you to make the decision, but I wouldn't go overboard with a high concentration in just one stock, no matter how confident I am about the company. Again, diversification is key. Also, putting your money in a pure cash account in your 401k may set it up for underperformance. Since your account is for a long term goal, you should pick investments that have good growth prospects.
4. Move to a rollover IRA once you leave the company.
For many of us, leaving an employer also means leaving our 401k behind and forgetting about it. As in my own experience, performing a rollover is a task that often falls by the wayside. But this is something that shouldn't wait: you should work on moving your money over to a high yield savings account using a rollover IRA registration. Be careful that you go through this process carefully so as not to incur penalties.
5. Contribute up to the match, at the very least.
The conventional wisdom here is that unless you have a lot of debt and need to reduce your debt load as a first priority, then you should open a 401k account. Most 401k programs have index funds you can invest in, by default, and also have an employer matching component. If you can afford it, contribute up to the maximum amount that is matched by your employer: a typical scenario has your company matching 50% of your first 6% of pretax dollars that you contribute to your 401k (or 403b) account. I've actually done a step further and have contributed the maximum allowable in all my retirement accounts, which has been up to 15% or more of my salary.
6. Be careful when you borrow from your 401k.
For those looking for affordable loans, one option has been to target their retirement funds as a source. Borrowing from your retirement plan is a pretty good deal since you're required to pay back the money plus interest over a certain length of time, and you're actually paying yourself that interest. But be careful: if you end up having trouble repaying this loan, you'll owe income taxes and a 10% early withdrawal penalty. I wouldn't go down this path unless I'm absolutely certain I can pay back what I borrow...only because I'm allergic to penalties and additional payments. So tread carefully!
In general, the investments that are housed in your retirement plans are typically protected by either FDIC or SIPC insurance, depending on what type of assets you hold. In my mind, there's no real good excuse not to own a 401k account, especially when you've got an employer match; it's a valuable benefit you shouldn't miss out on when you're working for someone.