How Hard is Your 401(k) Working?

ReShelle Barrett, CFP®

 Are you one of those employees who enrolled in your company’s retirement plan and haven’t looked at the investments since? Or worse yet, haven’t even enrolled in the plan? At least once a year, many will be asked to make decisions regarding your 401(k) plan i.e. would you like to enroll in the plan, do you need to change the amount of your contributions or the allocation of those contributions, etc. A 401(k) plan is an employer sponsored retirement plan that has replaced traditional pension plans at many companies. The main difference between a pension plan and a 401(k) plan is that with a 401(k) plan, the responsibility for funding future retirement benefits lies with the employee rather than the employer. For most of us today, your future standard of living depends almost entirely on you! With this in mind, here are a few tips to help you make the most of your 401(k) plan.

  • Start contributing today – setting aside as much as you can afford. Contributions to a 401(k) plan are made before tax. That means that contributions are deducted from your gross pay before federal taxes are calculated. Therefore, a 10% contribution to your 401(k) might mean only a 7% reduction in your take home pay. Start with a smaller amount then adjust as your pay increases. This also gives the dollars invested more time to grow.
  • Take some investment risks. Especially if you are more than 7 years from retirement, the combination of time and dollar cost averaging allows you to take on a bit more risk. Dollar cost averaging allows you to buy more shares when prices are down and forces you to buy fewer shares when prices are high. When determining your risk tolerance, it is good to remember that your time horizon is your life expectancy… not the day you retire. And the longer the time horizon, the more likely your portfolio is to withstand the short-term bumps in the market.
  • Diversify and be patient with your investments; don’t jump around. Different investments work well at different times and no one can predict which one will be best next. Bill Few always said, “Investing is like a bar of soap. The more you play with it the smaller it gets.” Spread your investments across different asset categories such as large and small cap stocks, international stocks, corporate bonds and cash.
  • Don’t be so quick to borrow. The idea of taking a loan from your 401(k), making payments to yourself rather than a bank might sound good, but remember that any outstanding loan balance is that much less money working for you.
  • Company match dollars are free money. Contribute at least as much as needed to get the full company match contributions. Keep in mind company match contributions are great, but should be looked upon as an enhancement, not a limitation.

These guidelines also apply to anyone covered by a 403(b) plan, Savings Plan, or any other employer sponsored retirement plan. Remember, it’s good to pay yourself first!