Editors' pick: Originally published Aug. 5.
Having a 401(k) in my younger years taught me some valuable lessons. Some of them good and some of them very bad, but that later led me to incredible opportunities. There is definitely a right and wrong way to handle your 401(k), and leaning heavily on your HR department is not one of them.
In 2008 I lost 38% of my 401(k) to the Great Recession. To say it put a bad taste in my mouth would be an understatement. But as with all falls or failures in life, you can choose to learn a lesson and make the loss a paid for educational opportunity. If you've decided to participate in your company-sponsored 401(k) you'll want to know these four tips for managing your 401(k) funds for the best results.
- Save while you are young
The sooner you can start putting money away the better. My clients that want to help their children save money are always shocked at how much their child can accumulate by retirement age simply by letting money compound and grow for 40 to 50 years.
You will never be unhappy with saved money, only with unsaved money or not enough saved money. Starting young gives your money time to grow. Only about half of employers in the U.S. now offer a 401(k) program. This is down from over 60% in 1999. Several major market corrections have hurt companies to the point that they can't afford to offer a plan or their employees simply don't use it. As of 2015, 68% of employees with access to a 401(k) opted not to enroll and participate.
- Alleviate contribution and rate of return pressure
Next to market loss, the greatest areas of pressure I see with retirement planning are in how much a person needs to save and the rate of return required to achieve their goals. The longer you wait and the less you save, the more you'll have to bulk up on the amount you put away in your later years. Waiting to save or saving less than you could now will put greater pressure on the amount you need to save down the road. If you are off on your goal by $500,000 and you only want to work 10 more years, you will have to place significantly more in the remaining years to hit your target.
The other option if you can't save as much is to earn higher returns. This can be dangerous. I see too many people because of time pressure, pushing their money to impossible earnings and losing because they took on too much risk. Greater risk may equal greater reward in some case but in all cases it also increases the likelihood you will lose part or all of your money. By saving as much as you can along the way, you won't have to save as much later in life, and you won't have to chase high returns.
- Where you invest matters more than being invested
Having your money invested isn't a guarantee you'll make money or achieve your financial dreams. Where you place your money matters. You should take some time each month to get educated on the options available in your 401(k). You should also rebalance your account every 6 to 12 month. So much changes each year and the allocations you chose in 2012 aren't right for 2016.
"According to a recent research report by the Investment Company Institute, less than 7% of American 401(k) participants made changes to their investment allocation last year," says Craig Wear, founder of Q3 Advisors and Game Plan Advisors. "Yet, stock and bond markets have become wildly more active and volatile over the last 20 years. Leadership among the different sectors of both changes with much more frequency."
"If rate of return is as important as we believe, then it would seem important to stay up with the trends in the movements of the market," Wears continues. "Rebalancing quarterly is a great standard and fits most 401k plan trading limitations."
- Don't overfund your 401(k)
You should become familiar with the matching contribution your employer is willing to offer. Since 2008, many employers don't match anything. In that case, you will be responsible for saving more. Always save up to the match but not anything over that. Many times people save and invest too heavily in their 401(k) and get in debt, have too much locked away until 59.5 and run the risk of creating a larger tax burden during their retirement years.
"If your company does not have a match, then you should at least target saving 10%, since it's all up to you to save," Wears added. "However, the single greatest challenge that my retired clients face after age 70.5 is the excess income tax that they pay due to their Required Minimum Distributions from their IRA's, which originate as their 401(k) account. Most of these retirees are required to take taxable distributions that are in excess of what their actual needs are for the year. This is extra income that they do not need and that they must pay the piper on when they receive them."
Don't just enroll in your company sponsored 401(k). If you are going to be involved, then get involved fully. Understand the programs and the investment options. Perhaps seek outside professional help to guide you in allocation decisions.
If you can save some tax now and get a match on your funds, then a 401(k) is a great option. If you don't, then you may want to eat the tax hit now in return for control and liquidity of your money. Either way, actively manage your 401(k) and save as much as you can. You're gonna need it!