Manage Your 401K Investments

A 401(k) is a retirement savings plan that is sponsored by your employer. The value of a 401(k) plan is that it allows you to invest money into your retirement fund before taxes are taken out of it. If you have a 401(k) plan, you have the option of deciding how your money is allocated. In other words, you can decide if you invest in stocks, bond or money market investments.[1] Given this flexibility, many people wonder how they should allocate their 401(k) investments.

Steps

Part 1 of 3: Learning About Your Investment Possibilities

  1. Investigate your employer's 401(k) plan. There are significant differences in 401(k) plans depending on your employer. Some employers will contribute more to your retirement plan than others, some make additional contributions based on profit sharing, some offer extensive choices as to where you invest, some have a set amount of time you need to work before you are allowed to keep company contributions, and some companies will automatically enroll you in a 401(k) plan.[2] Given all these differences, begin by studying what your company offers exactly.
    • You should be able to obtain this information from your plan administrator. She will have a prospectus that contains information on all of your options.
  2. Determine how much money you want to invest. Most financial experts suggest that you invest as much money as you can afford into your 401(k). The money put into your 401(k) is tax free until it is withdrawn, your company will often match a percentage of your investment, and it is money that you will use to live on when you retire. These are tremendous benefits and they should be taken advantage of when possible.
    • At the very least you will want to invest as much as is needed to get the full matching amount from your company.[1]
    • Suppose your company offers a 3% match. If you invest 3% of your $50,000 salary that will be $1,500. Your company will invest another $1,500. You want to maximize this.
    • Other 401(k) benefits include a lower taxable income. Your taxable income at the end of the year will be your salary minus 401(k) contributions.
  3. Remember that there are limits for contributions and rules governing a 401(k) plan. The IRS has limits for the amount of money that can be invested yearly and this figure changes from year to year. For 2015, those younger than 50 years old can invest up to $18,000.00 annually and those over 49 years old can invest an additional $6,000.00 more (which is called a "catch up" contribution). Your investment cannot exceed the lesser of 100% of your salary or $52,000.00.[3] By law you will have to pay tax on your investment when it is withdrawn at the age of 59 1/2 at your ordinary income tax rate. The IRS imposes a 10% early withdrawal penalty if funds are distributed earlier than this age in addition to the taxes owed.

Part 2 of 3: Reviewing Your Investment Options

  1. Figure out what is best for you and study your options. It is up to you to decide how your money gets invested so it is important that you take an active role in your investments. Begin by familiarizing yourself with the mutual funds your plan offers.[4] A mutual fund is operated by money managers and is essentially a large pool of money that your money will go into. These pools of money are invested in different ways, for instance in U.S. stocks, treasury bonds, foreign stocks, real estate, and much, much more.
  2. Research mutual funds in detail. If you elect to choose the mutual funds that you will invest in on your own it is important that you do extensive research. It is recommended that you consider the advice of professionals as well. While they will charge a fee, it may be worth it obtain this kind of guidance.[5]
    • Investment research companies provide comprehensive data about a variety of different investment vehicles. They can be good resources to educate yourself about particular funds.
    • Decide if you want a big or small fund and keep in mind that bigger is not always better. Funds with too much money may have difficulty coming up with new ideas on how to invest. Responsible investors should close funds before they get too big, but be careful.[6]
    • Look beyond the numbers. If a fund has performed well in the past check to make sure it is still under the same management. A key manager may have moved on meaning that the fund may not continue its strong performance.
    • Review any fees associated with the fund. The fee that is charged to run the fund is expressed as a percentage and is known as the expense ratio. These typically range from 0.15% (15 basis points or "BPS") to as high as 2.00% (200 BPS.) Funds with more active management will have a higher fee. If you are interested in this option, be sure it is worth the extra cost.[6]
    • Experts suggest looking for a fund with at least a five year track record.[7]
    • Look for no-load mutual funds which do not have a sales charge (commission) in addition to the fees paid within the fund.
    • Choose low-cost index funds when available and the performance is competitive with higher-cost funds.
  3. Consider a target-date retirement fund if you are not interested in doing extensive research. With this option, you will not be choosing individual stocks and bonds but instead you will have your investment managed by professionals; importantly, the target-date retirement fund is custom tailored to the year you plan on retiring. This is a simple option, where you basically need to pick the year closest to your retirement.
    • With the retirement year option the portfolio will include stocks, bonds and other assets with a level of risk that is appropriate to the number of years you have until retirement. Typically higher risk at the beginning and lower risk towards the end.
    • If you select this option have a good understanding of what you are investing in. Understand the allocation of your investment in particular - are you investing in stocks, bonds, cash, or a mix.[8]
    • Also, be sure to review any costs and fees associated with the fund.[8]
    • If you choose a target date retirement fund avoid investing in other funds. All of your 401(k) money will go into it; given that the target date fund disperses your investment among different stocks and bonds, there is no need to further diversify your money.

Part 3 of 3: Allocating Your Investments

  1. Know your time horizon. Your time horizon is the amount of time that you will be investing to reach your particular goal. In the case of a 401(k) you are investing for your retirement. So will you be retiring in months, years, or decades? The answer to this question should shape how you allocate investment in your 401(k).[9]
  2. Determine how much risk you can take in accordance with your time horizon. There is always risk with investment. Some people, however, can afford high risk - high reward investments more than others. You need to know how much risk you are willing to take. Traditionally, people with less time until retirement should take less risk than those with more time.
    • Aggressive or higher-risk investments include growth-oriented, small-cap, emerging and frontier market stocks. The appeal being the potential for higher return over the long-term while the risk trade-off is higher volatility along the way.
    • Conservative or lower-risk investments include money market accounts, certificates of deposit (CD's), high quality, short-term bonds or bond funds like Treasury bills, notes or bonds.
  3. Diversify your 401K portfolio. Many experts agree that diversity is the name of the game in investing. In other words, it is unwise to put all of your money in one place and it is best to put your money in many different places. This means that you should make sure to invest in a diversified mix of stocks of varying size, country and sector, as well as bonds of varying quality, term and type.
    • Some companies will allow its employees to invest in company stock. Be aware that doing so reduces diversification as investing in the stock of a company you already depend upon for your livelihood increases your overall risk should the company encounter difficult times or go out of business.



Tips

  • If you are younger than age 59.5 and you stop working for the employer that sponsored your 401(k), you have the option to do a "rollover" of your account balance into an individual retirement arrangement (IRA) or another 401(k) if you've started working for a new company that also provides one. Doing a rollover does not create a taxable event whereas if you were to take a distribution (cash it out) you would owe ordinary taxes as well as the 10% early withdrawal penalty.
  • Consider working with a financial planner or investment counselor. A professional can advise you as to which 401(k) funds are your best options. The fees such professionals charge vary so do your research to determine if you would like to work with one and whether they are the right fit.
  • Before getting started saving in your 401(k), first make sure you have enough saved in your emergency fund (3-6 months of expenses) for unexpected costs, such as job loss, illness, injury, etc. Also set aside in cash any amount needed for upcoming planned short-term expenses (automobile purchase, down-payment on a home, for example) in the next 1, 3 or even 5 years. Any amounts you contribute to your 401(k) should be thought of as long-term, not to be withdrawn until you are at least age 59.5.
  • 401(k) assets are held in trust, separate from a company's assets so that they cannot be used for running the company or be claimed by the company's creditors in the event of your employer running in to financial trouble.[10]
  • A vesting schedule is a period of time in which the portion contributed by your employer in the form of the company match to become wholly yours. A common vesting schedule might be 25% per year such that if you left the company prior to the end of four years, you would only receive a portion of the funds.

Warnings

  • Try not to make frequent changes to your 401(k) allocations. Most funds charge you when you make changes and you want to give your investments time to grow before you move them around. Set them and then check in on their performance once or twice per year to evaluate whether to rebalance your portfolio.
  • Not all employers provide a company match. If your employer does, the company match can be removed or reduced.
  • Remember that there is never a guarantee that you will make money in your 401(k). While most experts agree that saving for retirement early will give you a good amount of savings after 20 or 30 years, the market is volatile and you have to endure the market peaks and trough's over the years.

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Sources and Citations