Most people are introduced to investing through their 401(k) or other employer-sponsored retirement plans. For many, this is the first time they have had to make the decision to set aside money for their future, which often makes allocating investment choices all the more difficult.
Traditional 401(k) plans are tax-qualified, deferred-compensation plans in which you elect to have a portion of your wages contributed to your retirement plan on a pretax basis, meaning that your contributions are not subject to income tax withholding at the time of deferral. This enables you to save more money up front and pay less in taxes. You can save more money through pre-tax contributions in your 401(k) than an IRA or other investment savings vehicles. Additionally, when you save money from each paycheck before you receive it, saving for retirement becomes automatic and much easier!
Many companies also provide an employer matching contribution up to a certain percentage; for example, an employer may match dollar for dollar up to 3% of your salary and then $0.50 on the dollar for the next 2%. This is an incentive for saving and literally free money that the company is giving you just for participating in the plan. We highly recommend at a minimum, you contribute enough to receive the full employer match offered.
If participation is step one, allocating your investments is step two. Most plans offer a selection of mutual funds and exchange-traded funds to invest your savings. We recommend first looking at when you’ll need the money. 401(k) funds traditionally are meant for retirement, and generally aren’t accessible without penalty before age 59 ½. Government demographics say that the median age for workers is around 42, while the average retirement age is around 63. With at least a 20-year investment horizon, you can generally afford to invest more aggressively into mutual funds and ETFs that invest in stocks, rather than bonds, as you will have time to recover from normal market fluctuations.
Most companies should have a plan administrator or adviser who provides employee education on investing in your particular plan; however, investment selection is still participant directed. If education seminars are provided by your employer, take advantage of them, as they are part of the expenses your employer pays for the plan. You’ll likely learn about your risk tolerance, the funds available in your plan, and how to make changes to your investments.
When investing for growth, we generally recommend a majority of your investment to be in funds that invest in Large-Cap companies. These are the companies that can most likely weather recessions and inflation. Often a good place to start investing is with an index fund modeled after the S&P 500 index. Generally, these will mirror “the market,” so you should end up in line with the headline numbers you see in the news. You should also have some exposure to Small- and Mid-Cap companies as well as International companies. How much exposure depends on a variety of factors, including your time horizon, your risk tolerance, and investment choices available in your plan.
If you truly don’t have a clue and investing doesn’t interest you at all, you may consider a target date fund. These funds automatically adjust the asset allocation, such as, stocks, bonds, cash equivalents, in its portfolio as it gets closer to the specified date, which is typically the year that corresponds closely with when you will retire. However, that may not always be when you need the money. For example, if you retire at 60, you may have assets elsewhere that you’ll draw upon until age 70 ½ when required minimum distributions begin.
The bottom line is that you need to do your homework to understand what allocation will work for your goals. As your income and goals change, often so will how you allocate the investments in your 401(k). If you have questions regarding your retirement allocations, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.