7 Tips for Stress-Free 401(k) Investing
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If you’re lying awake at night wondering if your 401(k) is properly invested, it’s not much comfort to know that millions of other Americans are probably losing sleep over the same thing.
Roughly half of 401(k) plan participants find explanations of this type of retirement account more confusing than explanations of their health insurance benefits, according to multiple Charles Schwab surveys over the past several years.
Although 401(k) plans may seem complicated, they’re the best retirement savings option for most of us. As with any other savings vehicle, a little education can go a long way toward improving your returns.
Here are seven ways to wring the most out of your 401(k) account:
1. Get your full employer match
Find out if your employer matches your 401(k) contributions. If so, ask about the maximum match the employer is willing to make.
For example, if your employer matches contributions dollar for dollar up to 6 percent of your $4,000 monthly salary, you’ll get $240 free in your account for the first $240 you save — every month.
If you don’t take advantage of the employer match, you’re throwing away free money.
2. Bone up on 401(k) investing
Typically, you can choose from three types of investments for a 401(k):
Stocks : Stocks are basically ownership in a company. They offer the most potential for reward, but they also present the greatest risk.
Bonds : While stocks are an “ownership” investment, bonds are “loanership.” You’re lending money to a company (corporate bonds), local government (municipal bonds) or Uncle Sam (Treasury bonds). Generally, bonds pay a fixed rate of interest, are due on a certain date and are backed by the company or government agency that issues them. That’s why they’re considered safer and more stable than stocks.
Cash : These types of funds don’t earn much, but they are less risky than stocks or bonds.
3. Decide how much to put in each investment type
Here’s a simple rule of thumb often cited by Money Talks News founder Stacy Johnson: Subtract your age from 100. Use the figure you get as the maximum percentage of your savings you should have in stocks.
Say you’re 20. You could have up to 80 percent of your savings in stocks. But if you’re 60, keep it to 40 percent, because stocks are riskier and you’re close to retirement.
Once you’ve figured out how much to invest in stocks, divide the remaining part of your savings equally between an intermediate bond fund and a cash equivalent fund.
These percentages aren’t set in stone — they’re just a guide. Increase or decrease them to suit your needs and risk tolerance.
4. Keep expenses down
Investment fees can dig deep into your profits. Focus on keeping expenses super low.
Consider this example from “Of All the Fees You Pay, This One Is the Worst by Far”:
Say you have a 401(k) with a current balance of $25,000. Over the next 35 years, you earn an average return of 7 percent on that balance. Even if you don’t contribute another penny to your account during those 35 years, here’s how much money you’d have if your account fees were 0.5 percent, compared with fees of 1.5 percent:
Beginning balance | Annual return | Fees | Balance in 35 years |
$25,000 | 7% | 0.5% | $227,000 |
$25,000 | 7% | 1.5% | $163,000 |
So, the higher fee cost you an additional $64,000 over 35 years.
5. Use dollar-cost averaging
No one expects amateurs to know when to buy and sell stocks. Often it seems even the pros can’t get that right.
Fortunately, there’s no need to worry about timing the stock market if you use a simple system called dollar-cost averaging. That entails making your investments in fixed amounts and at fixed intervals — for example, $100 every month.
This method gives you insurance against market dips because you’re buying more shares when they’re cheap, and fewer shares when they’re expensive.
6. Choose index funds
There are two main types of mutual funds. How these funds are run affects their fees:
Actively managed mutual funds , or active funds, are run by financial professionals who decide which stocks or bonds to buy and sell within the fund. They aim to outperform stock market indices — and charge higher fees for their effort.
Passively managed mutual funds , or index funds, simply aim to mirror a stock market index such as the S&P 500. Fees are therefore minimal.
Recent surveys have found that the average expense ratio of active funds is more than four times higher than the expense ratio of index funds.
7. Consider target date funds
This popular type of mutual fund is appealing because it takes a lot of the work out of investing. You just choose the date when you want to retire — 2030, for example. The fund is designed to do the rest, rebalancing your asset allocation over time based on your retirement date, or “target date.”
To learn more about the pros — and cons — of this type of investment, check out “6 Tips for Picking the Best Target Date Fund.”
Are you confident your 401(k) will produce the money you need when retirement comes? Share your thoughts below or on our Facebook page.
Ari Cetron contributed to this post.
This article was originally published on MoneyTalksNews.com as '7 Tips for Stress-Free 401(k) Investing'.
