One of the first lessons investors learn is that investing in their company’s 401(k) plan is a good deal. It saves pre-tax dollars for retirement, and if you get an employer match, it is like giving yourself a raise. Choosing to participate is generally a no-brainer, so most investors pour their efforts into picking the right mutual funds and allocating their investments according to their age, risk tolerance and investment horizon. If you are like most, there are still some key areas that might be overlooked.
Here are five tips to keep your 401(k) on the right track:
Tip No. 1: Understand it is how much you save, not so much the details of particular investment choices.
Most investment advisers will tell you the key to having enough money for retirement is saving aggressively, not investing aggressively. It is through the power of compounding returns that an investment account will grow to a substantial amount of money, even in conservative investments. While investment selection is important, how much you save and how early you begin saving makes the most difference.
Let’s say when you retire you want to have $60,000 a year after tax to spend. Let’s assume you have 30 years until retirement, and assuming a 4% inflation rate, at age 65, you will need $2.5 million in the bank to carry you from ages 65 to 90. Assuming you can get a 10% return on your investments, you need to save $15,500 a year. However, if you have just 10 years until retirement, you would need to save $72,000 a year just to have $1.1 million by the time you are 65.
Your priority should be to first figure out how much you need to save to meet your retirement goals, and then begin saving as soon as possible.
Tip No. 2: A company match is great, but make sure it is your money before you count it.
Many plans have a vesting period. Vesting is the process by which employees accrue non-forfeitable rights to employer contributions that are made to the employee’s qualified retirement plan. You are fully vested in the contributions you make to your account through salary deferral.
An employer match occurs when a company agrees to add money to an employee’s retirement plan, if the employee also adds money to it. Therefore, you can basically give yourself a raise by taking advantage of this option, if it is offered. For example, an employer may offer to “match” 50% of your first 6% of contributions to the plan. This means that if you invest 6% of your salary into the retirement plan, your employer will add another 3%. If this deal is offered, take advantage of it. It is as good as being handed free money.
However, you may be obligated to work for the company for a specified number of years to be fully vested in the matching contributions. If you leave the company before the vesting period is up, you may only receive a percentage of the match. If you are a young worker and actively pursuing your career, you may only spend three to four years with your employer before seeking a better job. Some plans take six or more years to become fully vested in your employer’s match. If you think may leave the company sooner than the vesting period, you should consider saving more to meet your goals.
Tip No. 3: Consider the investment options in your spouse’s plan and your other investment accounts.
A survey of retirement plan participants by Fidelity showed that only 38% of couples make decisions together about retirement savings. At least once a year you should look at you and your spouse’s investment options and consider them together. You may find out that you are overweighted in bond funds more than you need. You also may find out that your spouse’s plan has better small-cap fund options than your plan, while you have better international funds. By considering your investments as a whole, you may find ways to diversify your investments to your advantage rather than opting for index funds across the board.
Tip No. 4: Keep your exposure to your company stock to a minimum.
At Henssler Financial we advise never having more than 10% of your portfolio invested in any one company, particularly the one you work for. Many individuals receive stock options from their employer, matching contributions in their 401(k) plans, participate in their employer’s stock purchase plans, as well as receive their income from the company. Unfortunately, many people do not properly diversify their portfolios when they receive the stock benefits from their employer. If your employer’s stock comprises more than 10% of your total portfolio, you risk losing a large portion of your retirement portfolio. If the company goes out of business, you would not only have lost wages, you would lose your savings in your retirement plan, employee stock purchase plan, and stock options.
If you feel you need to participate in the company stock purchase plan to be politically correct, invest the smallest amount possible. You may also want to find out if you can direct the company’s matching contributions to other investments in your 401(k) plan.
Tip No. 5: Do not pick funds based on performance alone.
A fund’s performance depends on many factors, but what is very clearly spelled out in the fund’s prospectus is the expense ratios.
Depending on the type of fund, operating expenses vary widely and must be paid from fund assets. These costs are incurred through marketing, advisory fees, accountants’ fees, legal fees, custodial fees, etc. A fund’s expense ratio is determined through an annual calculation, where operating expenses are divided by the average dollar value of the fund’s assets under management. Operating expenses are taken out of a fund’s assets and lower the return to a fund’s investors.
The expense ratio is separate from Fees imposed on the transaction. Transaction fees—usually either a commission or sales charge—are charged directly to the investor as a load. Many investors seek no-load funds because there is no transaction cost, thus all of the money invested is invested in the fund.
It is important that you consider all fees and charges when selecting your mutual funds. Some no-load funds have a considerably higher expense ratio than others. Small Cap, Mid-Cap and International stock funds can also have higher expense ratios than Large Cap stock funds, as research on the companies in which these funds normally invest is more difficult to find and evaluate. Look for funds that have the lowest fees. Paying excessive expenses for a fund will eat away at your gains.
401(k)s are normally an easy way to invest for your retirement. Young investors saving small amounts of money each year can take advantage of compounding over a long period of time in a tax-advantaged investment vehicle. If you have questions about your 401(k) or retirement savings strategies, you may contact Henssler Financial at 770-429-9166 or experts@henssler.com.
Disclosures
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
