The recent SECURE Act 2.0 has ushered in greater pressure to use the 401(k), 403(b), or TSP accounts as core retirement plans, but most Americans do not understand how these retirement accounts work. The current financial education system in high school is antiquated and sets up young adults for a lifetime of being poorly prepared to make responsible retirement savings decisions.
In this video, I am going to show you the mysteries of the 401(k) accounts, how to deal with them. More importantly, step-by-step, how I have increased my 401(k) from zero to over $200,000. First, you are going to learn how to pick the perfect 401(k) investment funds and then come to understand how to pick among those that are available. How it works, plus ways to assess and employ effective strategies, can lead to better decision-making that has a significant consequence on your retirement savings. In this, I will be guiding you on the best 401(k) investments to consider so that you can maximize your savings and head into a financially secure retirement.
How a 401(k) Works
Maximizing Contributions and Employer Match
From 2017 to 2021, I contributed the maximum allowable limit each year to my 401(k), and it grew significantly with my employer matching. The following steps were vital in the success of this approach:
- Max Contributions: Make a habit to always put in what the maximum allowable limit is every year.
- Employer Match: Always get the full employer match by keeping an eye on how much you contribute.
- Investment Research: I researched where each of my dollars in my 401(k) was invested.
- Market Conditions: Fortunately, this was a pretty good time for the markets.
401(k) Investment Options
Traditional vs. Roth 401(k)
- Traditional 401(k): Contributions are off the top, pretax dollars. They decrease one’s taxable income for the present year.
- Roth 401(k): Contributions are after tax, but it will come out tax-free when one decides to pull from it in retirement.
Employer Match Contributions
Employer matches typically go to the Traditional 401(k) portion unless you choose to convert them to Roth.
Picking the Right 401(k) Investment Funds
Risk Tolerance
The first step in selecting the appropriate investments is to understand your risk tolerance. Here’s how you find out:
- Rule of 110/120: The formula involves taking a number, either 110 or 120, and then subtracting your age. This should give a percentage of the total to be placed in stocks versus bonds. For example, at 31 years of age I was taking the Rule of 120 that gave me 89% stocks and 11% bonds.
Investment Option Analyses
When analyzing options for 401(k) investments:
- Asset Classes: First identify if it is a fund that invests in either stocks, bonds, or both.
- Risk Indicator: Consider the ranking of the risk rating for each fund on a scale typically ranging from 1-most conservative to 5-most aggressive.
- Expense Ratios: Usually, the lower the expense ratio, the better one’s net returns would be. For instance, a fund with an 0.08% expense ratio is generally better than one with a high ratio.
Target-Date Retirement Funds
- Automatic Rebalancing: These funds automatically change their allocation mix as you approach retirement. For example, a 2050 Target Retirement Fund would start automatically rebalancing from stocks into bonds the closer you are to that date.
Self-Directed Brokerage Accounts
- Advanced Option: For the more experienced investor, a self-directed brokerage account enables you to hold individual stocks, ETFs, or other various assets inside your 401(k). This requires active management and knowledge of the markets.
Practical Steps for Investing in 401(k)
- Review Choices Available in Your 401(k) Plan Consider the different asset classes, risk levels, and relative expense ratios of the investment options available to you under your company’s 401(k).
- Invest According to Your Level of Risk Tolerance Put money into a fund that reflects your risk tolerance based upon age and financial position.
- Target-Date Funds Are Simple If you’d rather not think about switching over time, Target-Date Retirement Funds automatically rebalance to lower risk as you approach retirement.
- Know Your Self-Directed Options If you have more investment knowledge, you may want to transfer some of your 401(k) into a self-directed brokerage account for more control.
- Seek Professional Advice If you are not comfortable in making those investment decisions yourself, engage the services of a financial advisor who will help you based on your personal goals and overall risk tolerance.
Conclusion
The selection of the right 401(k) investments is just one important step toward having financial security throughout your retirement. Understand how 401(k)s work, check on the investment options, and apply effective strategies in order to make informed decisions that would lead to long-term benefits. Whether you want to choose between traditional investments, Roth contributions, or even self-directed accounts, make sure that the decision remains within your level of risk tolerance and retirement goals. Done correctly, this can be the most effective way to maximize retirement savings and set yourself up for financial security later.