Do you have a 401(k) plan? Better yet if you have one do you understand it? Most workers now have company sponsored 401(k) plans and when they first started many were less than desirable when it came to investment choices. But in recent years 401(k) plans have gotten more and more choices and have seen expense ratios fall. With a little effort anyone can take control of their 401(k) and in return their retirement. The following are some areas that may not be the best for employees but there are ways to fix the issue and make your 401(k) work for you.
Many employers are now enrolling new employees in the company’s 401(k) plan automatically. In recent years 401(k) plans have seen the participation of eligible employees grow due to this action by employers. But a drawback to the auto-enrollment is some employers have reduced the amount they will match due to the increased participation. While younger workers are saving the benefit from the company in the form of matching may not be as high as it was prior to this action becoming the normal course of action by employers. Another drawback is twofold in nature. Many employers set the initial savings for the employee’s 401(k) at about 3% and then they will default the money into the most conservative of the investments that the 401(k) offers. The problem with this approach is 3% is not even close to what someone should be saving into their 401(k) as many financial planner recommend at least a 10% contribution. Secondly by investing in the most conservative investment the employee while they may not lose principal chances are the gains they make will not keep up with inflation. Now starting out it may be difficult to save 10% of your salary but when you are younger and starting out raises are fairly common. The key here is to set up automatic increases in your contributions if your plan allows for that. The second is when you do get a raise increase your contribution percentage so you will not really notice you have saved more due to the fact it is automatically taken from your check before you even see it.
One of the largest complaints by 401(k) participants was that they were expensive for participants and that they had few options. In the last 10 years expense ratios have dropped almost .1% mainly due to litigation that was instigated by employees against their companies. Now larger companies have access to funds that have lower expense ratios but that is a result of economies of scale. But prices are coming down for all employers in general for their plans and the expenses associated with them. Regardless of the expense ratios it is important to always contribute up to the company match or you are throwing free money away. Regardless of the expense ratio free money is an immediate return on your investment and will outweigh any costs associated with the 401(k). But if your plan does have unusually high fees fund up to the company match then fund a ROTH IRA with the difference in low priced ETF’s or indexed mutual funds.
Many larger funds now have some form of fund management for your 401(k) contributions. While as of now this is limited to larger employers who have a large amount of assets under management in a 401(k) plan they may become available to medium and smaller plans as they become efficient. This management services will aid in picking asset classes or even rebalance your assets for you to achieve your retirement goals or to stay within your risk tolerance ranges. But as you are in this plan for the long term and not for short term gains the best approach is to find a low expense indexed fund within your 401(k)’s plan and invest in that. Over the long haul this has proven to be an effective investment strategy. And again if your plan does not offer what you consider to be good choices contribute up to the match then fund your IRA to its maximum then switch back to the 401(k) to save additional money until you have maxed it out as well.
And to answer the old question of when to start saving that is start saving as soon as you can. The power of compounded interest over 30 plus years will amaze you. If you want to see what it will cost you to wait 5 or 10 years open an Excel spreadsheet and use the Future Value function. Fill in your variables and see what it will cost you to wait. 5 years can make a huge difference in what your account can end up with in 30 or 35 years. Play with the numbers and see for yourself.
If your company has limited options for investments in the 401(k) plan remember to always invest up to the match so you are not leaving free money on the table. But if the plan is heavy on your company’s stock definitely contribute up to the maximum then fund your IRA. After the IRA is funded go to a brokerage account and buy equities that are tax efficient in such an account. Remember dividends and capital gains are tax advantaged so equities are a good choice for a brokerage account.
Not all 401(k) plans are set up to be advantageous for the employee but with a little work on your part and creativity you can still save effectively. Remember retirement for most of us is many years away and with proper planning it can be comfortable for you. If you are closer to retirement still contribute to your company’s plan but it may be wise to seek the guidance of a financial planner to help iron out the smaller details.
