401(k)

What you need to know about your 401(k)

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Your 401(k) can make you one millionaire. Here’s a simple, 10-step 401(k) strategy for 20- to 30-year-olds that will help you get the most out of your pension savings.

Your 401(k) can easily turn you into a millionaire. Your savings will grow tax-free over 30 or 40 years by making small, regular investments starting in your 20s or early 30s.

While opting in is the most important step you will take to make 401(k) contributions, using a sound 401(k) plan can boost your returns and help you hit the $1 million mark faster.

Sometimes it’s best to put your money on the autopilot. You will never worry about running a paycheck to the bank if you have direct deposit. If you have an automated bill payment you will never miss the due date of a credit card or utility bill

Yet autopilot is definitely not the way to go when it comes to your 401(k)—even if your employer takes deductions from your salary you barely know. That’s because 401(k) plans rely on their asset allocations to expand, and hundreds of thousands of dollars will increase your lifetime earnings by just a few hours of education and application.

Here we detail a 401(k) plan in 10 steps

1. Also optimize your match with your employer

No-one would, in principle, turn down free money. But that’s just what many People do when an employer offers them to drop the ball on matching retirement funds.

Most employers can contribute up to 50 percent (or at times 100 percent) of the money you, the employee, put into your 401(k), up to a specified maximum percentage of your salary.

Ignoring this advantage by either not opting into your 401(k) or refusing to contribute to the amount it will suit your employer practically leaves a portion of your earnings on the table.

2. Using Roth IRA to complement the 401(k)

Some 401(k) employers are suffering from a lack of investment options. This is where a customized retirement account (IRA) comes in handy.

And if your employer does not match contributions, you may choose to forgo your 401(k) entirely, says Ned Gandevani, program coordinator and professor at the New England College of Business’ Master’s of Science in Finance program. “If your employer does not contribute to your scheme there is no need to participate in it. Through investing in a limited package, you end up paying too much without your employer getting any benefits.

3. Hold your 401(k) in order

Stocks might be the most risky investment you can make, but if you want an average annual return of 8 percent (or more) they’re also your best bet.

The key is to make sure they fill your 401(k) with them.

You will be given a worksheet or guided to go online to choose how to invest your money when you apply for your 401(k).

Unfortunately a lot of investors blindly pick.

That’s wrong, because most of the 401(k) programs offer somewhat specific purpose-based investments. Some will be bullish equity funds designed to maximize long-term gains, but others will be cautious funds with mostly bonds and cash holdings.

Such funds are meant to minimize losses, thereby creating a much smaller annual income. If you’re close to retirement, that’s good, but not so good if you’ve got 30 years to spend.

Amy Merrill, a principal with TrueWealth Management in Atlanta, suggests holding onto US stock funds, international stock funds, and real estate stock funds when choosing investments in your 401(k). “Look at the choices made by your fund and try to find a fund that is more like a category stock index”

4. know when to spread out

Young investors in their 20s and 30s are mainly looking to invest in stocks. Yet this does not mean that you can ignore other types of assets such as shares and alternatives. A stock-to-bond ratio of 80/20 sets a strong benchmark for investors aged 30 and younger.

Another thing to consider for more hands-on investors is valuing asset classes at the time you invest. Also if you shouldn’t try to time the market, you might fairly look at the S&P 500’s recent run and be cynical about its upcoming near-term results.

Because you’re investing for 30 years or more, that’s definitely not a reason not to invest in stocks, but it might make you consider allocating some of your funds to struggling assets that will come back with time, like those in Europe

5. Do not get too engrossed with your stocks

Although taking advantage of discounted employee stock purchasing plans is wise, the retirement portfolio should not be dedicated to more than 10 per cent.

Nonetheless, your portfolio should not be heavily concentrated in any given stock. But if you lean too heavily on employer stock, if your business goes bust you might suffer a significant investment loss.

6. Always improve on your inputs

A lot of investors only contribute enough to their 401(k)’s to get the match for the product. That is typically not enough to guarantee your retirement sadly. Experts recommend a range of 10 to 15 per cent. However if you cannot start there, it’s a good idea to increase your 401(k) if your employer gets a pay hike.

7. Hang around for a better 401(k)

Your 401(k) is sometimes low, because your employer has not done enough with the overall plan.

“I will let you in on a trade secret: participants are terrified of program sponsors,” says Brandon Grandbouche, a senior investment analyst with WealthHarbor Capital Group in New Orleans. “Employers are often engaged in running the day-to-day business affairs and may find it difficult to keep up with all the fiduciary duties of running a plan.”

If you are disappointed with the investment options or fees in your 401(k), talk to your plan sponsor or HR department about possible remedies.

8. Equal retirement savings and debt repayment

Saving for retirement is most definitely not your primary financial target. Far be it.

You’ll also have to balance your 401(k) investments with paying down debt or saving for other goals such as a house or family.

That’s all well. Don’t just use competing goals as an excuse to forgo 401(k) contributions. To make your 401(k) a million-dollar nest egg, you’ll miss out on the prime years. Even if you have debt, make sufficient contributions to your 401(k) to get your employer match. Then, as you clear money out of the debt pile, redeploy the funds through payroll deductions into the retirement pile.

9. Never take likely your compound interest

Starting a retirement account at age 20 versus 30 with steady contributions makes all the difference in the world.

“Albert Einstein once called compound interest’ the most strong force in the universe’ and he was a pretty smart guy,” says John McFarland, organizer of the Virginia Commonwealth University School of Business Financial Planning project. (Note from the editor: there’s no proof that Einstein ever said that, but it’s become a personal legend of finance.) Let’s say a 20-year-old starts plunking down just $45 a month with a 50 percent bet. When she raises donations by the same amount as any pay raises that she receives, by age 65 she will have more than $1 million.

10. Leverage on Professional advice

70 per cent of participants said in a survey of Schwab Retirement Plan Services in 2014 that they would be somewhat or highly confident in making 401(k) investment decisions with professional assistance. That’s compared to just 39 percent who had the same confidence when making their own decisions.

 

But it’s not just about feeling safe-it’s also safe. “We have found that nine out of 10 therapy takers stayed the course during the financial crisis of 2008,” says Catherine Golladay, 401(k) Participant Services vice president of Schwab. “The outcome was they were well positioned to take advantage of the rebound from the market.”

Komolafe Timileyin is a passionate entrepreneur that loves to solve entrepreneurial issues. He is also a blogger and an upcoming Engineer.

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