How To Make Maximum Money On Your 401(k)
If you’ve worked for two or three decades you might remember the glory days of the pension. You placed a certain amount of money into an account and when you retired you started receiving checks. There weren’t a lot of management responsibilities other than to keep working to amass more retirement money.
That was then. Today, it’s all about the 401(k). You’re now responsible for your own retirement. A portion of your paycheck, often along with a little incentive from your company, goes into an account and you – the person with little investment knowledge – are charged with managing the most important future financial vehicle you have. Does it seem a little daunting? It should.
Let’s set some foundations that will help you manage your 401(k). With the right basic principles in place, you'll be in a better position to make the decisions that relate to your individual financial situation.
1. Should You Pay for Account Management?
There are plenty of financial advisers who would love to manage your account providing you meet the minimum balance requirements. There are also online services that can help you make good financial choices even if your balance is small.
Is the cost worth the return? According to a 2014 report published by the retirement investment firm Financial Engines, Inc., assets managed by professionals saw an average of 3.32% more in returns than accounts without professional management.
Some online service might only charge 0.15% while professional managers could charge 3% or more.
In general, if you have little investment knowledge, it’s worth getting help. However, some 401(k) plans offer free advice from a professional or might give you model portfolios to follow. Don’t pay somebody until you know all of your options.
2. Contribute the Maximum up to the Match
If your company is matching your contributions up to a certain point, contribute as much as you can until they stop matching your contributions. Regardless of the quality of your 401(k) investment options, your company is giving you free money to participate in the program. Don’t say no to free money.
Once you reach the maximum, you might consider contributing to an IRA, but until the match runs out, it’s a no-brainer.
3. You Have to Rebalance
Would you buy a new car and never change the oil? Would you purchase a home and never mow the lawn? Life is full of routine maintenance; your 401(k) needs maintenance too. In the investment world, rebalancing is another term for maintenance. As investments move up or down in value, they become a smaller or larger percentage of your overall portfolio.
Financial advisers suggest having a set allocation of stocks and bonds. If you’re 40 years old, you might have 80% of your money in stocks and 20% in bonds. If that allocation becomes out of balance, you may have to buy or sell assets. See How do I know when to 'rebalance' my investments?
4. Learn the Basics of Investing
In order to evaluate different funds in your 401(k) or to understand the strange words a financial professional is speaking to you, you need a basic knowledge of investing. Understand terms like 12B-1 fee, expense ratio and risk tolerance. Read through the information sent to you by your plan. If there are terms you don’t know, look them up. (Investopedia has more than 14,000 terms in its Dictionary, so start here.)
5. Learn to Love the Index Fund
Some people love the appeal of stock picking. Finding the next Google or Tesla that will return hundreds of percentage points over a relatively short amount of time is thrilling, but according to research the gamble generally doesn’t work very well.
An index fund simply follows a market index. A fund that follows the S&P 500 rises and falls with that index. There’s no guessing which stock will outperform the market and the fees you pay for index funds are almost always much cheaper than for funds that try to pick the next great stock.
There’s plenty of research that shows index funds outperform over the long term.
You should never make short-term decisions in your 401(k) anyway. If you fancy yourself a Wall Street trader, do that with money outside your 401(k); your retirement account is better suited to allocating large amounts to index funds.
6. Don't Just Settle for the Target Date Fund
Think hard before you simply invest your 401(k) in a target date fund. The idea of these funds is that they're geared to evolve as you move closer to retirement. If you’re planning to retire in 2040, for example, you would invest in a target date fund that matures in that year. The fund’s managers will continually rebalance the fund to maintain an appropriate allocation as the target date gets closer.
Here's why this may not be the best route: For starters, funds use different allocation strategies, which may or may not be a good match with your goals.
As experts point out, a target date fund’s performance is largely based on the managers. Since you probably don’t know the good mangers from the bad, picking a fund is difficult.
Equally important, fees for these funds are often high, and novice investors don’t understand the golden rule of target date funds: If you invest in a target date fund, you shouldn’t mix it with other investments. Most financial advisers agree that it’s close to an all-or-nothing investment. Investing your 401(k) in other funds throws off the allocation.
One-stop shopping is appealing, but just because it’s a simple way to invest doesn’t mean that it’s easy to understand. To learn more, see An Introduction To Target Date Funds and Who Actually Benefits From Target Date Funds?
7. Don’t Rely Solely on Your 401(k)
Your 401(k) should be one of multiple retirement vehicles. Your home, a side business, collectibles and other investment accounts such as an IRA might be part of your mix as well. When you switch jobs, consider whether it makes more sense to roll over your previous company's 401(k) into your new employer's plan or invest it in an IRA; the latter may give you more investment choices. Spread your assets over multiple income streams and you’ll likely see better returns.
The Bottom Line
Regardless of your age, you have to take an active role in your retirement planning. Sometimes that’s as easy as monitoring your investments after exhaustively researching your options. Other times, it might mean working with a trusted financial adviser to set long range goals.
Retirement will sneak up on you faster than you think. Whether you’re just starting your career or quickly coming up on retirement age, make retirement planning a top priority throughout your life.