Blog

For many people the 401k is their first exposure to the stock market and also saving for retirement. While it can be exciting; it also can be overwhelming for most people who aren’t comfortable with 401k plan rules, investment options to choose from, and what to save into their 401k. Here are some pointers and information to lower the blood pressure

To start, a 401k plan is a long-term savings account for retirement. Rules are designed for this purpose, so don’t treat it as a savings account at the bank where you tap into it for the next car or vacation fund. At 59.5 years of age you can take a withdrawal from the account without penalty. 401k’s are considered tax-deferred accounts, meaning any gains incurred or dividends paid from the investments are not taxed as long as they stay in the account. This is HUGE. With the power of compounding this can help workers over time keep growing their savings without taking a tax hit. Withdrawals in retirement are treated as taxable income, so you can’t avoid taxes altogether but the delay is well worth it!

Whatever you contribute to your 401k is yours to take immediately if you leave your job. If you do get a matching contribution from your employer there are separate rules pertaining to your length of service that will dictate if that money is vested, or yours to take when you leave the employer. Once you leave the employer you can’t add additional money into the 401k.

Now to investment options. NO RISK EQUALS NO REWARD. Everybody has a different level of risk they can handle, but at the end of the day you won’t touch your 401k for many years or decades. Take on some risk, higher stock allocation, in the 401k to get some decent returns to grow your money over the long run. As you approach retirement lower the risk, add to bonds, so that a bad stock market period like a 2008 won’t derail your retirement plans. If you are 10 or more years away from retirement a 2008 WON’T derail your retirement plans, it can actually create an opportunity to buy investments at cheaper prices.

Look at fees of the funds available in the 401k along with performance. Typically an employer will set up a default fund they will enroll you in based on your age and retiring around 65 years of age. These options can be ideal to get started if you want to have the 401k in auto pilot- meaning for example a Target Retirement 2050 fund will be aggressive for the worker upfront, and as they closer to retirement at 2050 the fund will get less risky automatically for all investors in the fund. Most importantly don’t check your balance daily, or even weekly, as there will be some ups and downs dealing with the stock market. This can lead to human emotions getting the better of people and leads to bad decisions, such as market timing. Check your accounts quarterly to make adjustments and you will be just fine.

Lastly, many people struggle with what they should save towards their retirement. In short the more the better, especially if you can start at a younger age. If your company offers a match you should at lease start at that level, as this is FREE MONEY. In the long run if you can save 10-15% of your income you will be great in the long run. Try making small changes over time, meaning increasing your contributions by a percent or two. A good time to do this is when you get a promotion or a healthy merit increase at years end. The biggest mistake people make is they spend all of their money and rationalize they “don’t have enough income to save.” I would argue to start saving first, then look at your budget and live on the rest of your income. If you never make a small sacrifice in the present, you will most likely will never gain a larger benefit down the road. I’ll leave you with a great quote from legendary businessman and investor Warren Buffet. “The biggest mistake is not learning saving properly.”Do not save what is left after spending; instead spend what is left after saving.”