A 401(k) account is a retirement plan set up by your employer in which you contribute part of your earnings is one of the best ways to save. These accounts provide significant income tax savings, and many employers match a portion of your contribution. Make the most of this great investment by following a few simple steps.
First, determine your financial need at retirement. This helps establish the monthly savings required to reach your goal.
Next, contribute as much as you can as soon as you can, so your money will have longer to multiply. For example, if you’ll need $500,000 when you retire in 30 years, you must save about $230 a month at a 10 percent return. Putting off saving for five years increases the monthly figure to $385, and waiting 10 years requires saving $661 monthly.
If your monthly savings goal is too high based on your current expenses, invest at least enough to receive your full employer match. Saving less is like turning down free money.
Deciding where to invest your money depends on your retirement time frame. If retirement is more than 10 years away, regular contributions into stock mutual funds likely will produce the highest returns. Stock index funds, mutual funds where the manager buys all the stocks in a market benchmark or index average (such as the DOW Jones Industrial Average), are the best option. These funds include shares from a large number of stocks and consistently outperform most other stock mutual funds because they keep operating costs low, thus having more to return to investors. If your 401(k) doesn’t offer an index fund, ask your employer to get one. Until this happens, invest in stock funds with consistent track records, low operating expenses, and good returns.
If your time horizon is shorter, between five to 10 years to withdraw money, for example, split your investment between stocks, bonds, and cash. Visit www.quicken.com for specific allocation advice for your stage in life.
If your company matches your contribution by investing in its own stock, do not invest your portion in the stock. Otherwise, you’ll have all your eggs in one basket and will be exposing yourself to substantial risk.
Borrow from your 401(k) only in cases of dire emergency. Borrowing will lose that money’s earnings as well as its future worth. Compounding interest is a double financial whammy. Plus, if you change jobs, you might have to repay the loan immediately with interest.
These simple steps can mean the difference between a comfortable retirement and working a lot longer than you had planned. Follow them consistently and your retirement will be all that you want it to be.