A 401(k) plan is one of the best resources available for saving and investing for retirement. It’s a win-win situation: you can reduce your taxable income in the present while preparing yourself financially for the future. There’s no right or wrong way to manage your 401(k), but there are tips and best practices that can help you get the most out of your plan or avoid doing things that will slow you down. your progress.
Here are three things that could kill your 401(k).
1. Not taking advantage of an employer match
One of the best parts of many 401(k) plans is the employer correspondence, because it’s essentially “free” money. At the very least, the minimum amount you should contribute to your 401(k) is the percentage your employer will match. If they offer a dollar-for-dollar match of up to 3% of your salary, contribute at least that 3%. There are few exchange guarantees, and an employer match offers an instant return on your contributions.
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So if you make $100,000 and your employer gives you up to 5%, not only is that an extra $5,000 in the present, but it’s also an extra $5,000 in your holdings that have time to grow and accumulate. Even with a modest 8% average annual return, $5,000 could turn into over $23,000 after 20 years.
2. Strictly rely on target date funds
Target date funds are designed for people who want to take a “set it and forget it” approach to their 401(k), and that’s not necessarily a bad thing — it’s just often expensive. As you get closer to retirement, target maturity funds automatically reallocate the investments they hold to become more conservative, shifting from stocks to more bonds and cash. Because they handle reallocation for investors, target date funds tend to be more expensive than other index fund options.
But a target date fund is often a “fund of funds,” so instead of paying the high fees that usually come with them, you can invest in the cheaper fund options yourself. As long as your 401(k) elections include a variety of large-cap, mid-cap, small-cap, and international funds, you’re in great shape. Going this route can easily save you tens of thousands of dollars in fees over the life of your 401(k) plan.
3. Being too conservative away from retirement
Everyone has a different appetite for risk. However, regardless of your risk tolerance, it’s important to remember that in your youth, when you’re decades away from retirement, you need to focus on growing your money, which usually means taking on more risk. . You’re unlikely to generate the savings that many people will need in retirement by investing strictly in low-risk, low-return assets like bonds.
As you approach retirement, you can focus on preserving your portfolio. Small- and mid-cap stocks are generally riskier and more prone to volatility than large-cap stocks, but they also present a chance for higher returns thanks to their greater growth potential. They shouldn’t make up the bulk of your 401(k) portfolio by any means, but you definitely want some exposure to small- and mid-cap stocks.
This does not mean taking excessive risks, especially if the resulting volatility prevents you from sticking to your long-term investment strategy. But if you’re decades away from retirement, take advantage of the long-term horizon and give yourself room for higher returns.
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