Be a smarter investor in your retirement plan
So you've signed up for your employer's 401(k) plan and are making regular contributions through your paycheck.
You're already off to a great start.
But if you really want a fighting chance at a secure retirement, you're going to have to become a smart investor. That means mastering a few key concepts.
Let's start with the two most important questions you'll need to answer, according to David Blanchett, head of retirement research for Morningstar Investment Management:
- How much of your income should you save?
- How should you invest that money?
How much should you save?
Many employers now automatically enroll their workers in a retirement savings program. So if your company has a 401(k) plan and you do nothing, you'll probably be signed up for it anyway.
But just because your company enrolled you doesn't mean you're saving enough. The default contribution rate your employer set might be 3% or less.
Terrance Odean, professor of finance at the Haas School of Business at the University of California, Berkeley, says you should save 10% to 15% of your income.
For 2019, you're allowed to contribute up to $19,000 in pretax income to your 401(k). That limit increases to $25,000 once you turn 50.
If you can't contribute at least 10%, make sure you're saving enough to capture any match your company offers. A match is the amount of money your company is willing to put into your 401(k) on top of your own contributions.
You can ask your human resources department or plan administrator whether your employer offers matching contributions. It will typically be a portion of every dollar you contribute, up to a certain percentage of your annual income.
Let's say you have a $50,000 annual salary and your company matches half of your contributions up to 5% of your income. If you contribute $2,500, the company will throw in another $1,250.
That's $1,250 in free money.
"Start by saving enough to make sure you're getting the full match. Not doing so is like not cashing your paycheck," said Odean.
How should you invest?
Now it's time to figure out where you should invest your money.
Even if you voluntarily enroll and don't choose your investments, you'll likely end up in a target-date or balanced fund as a default option.
That's not necessarily a bad thing.
Target-date funds have one major advantage: They put you in the right mix of stocks and bonds based on your age, Morningstar's Blanchett says.
Fund managers rebalance the mix yearly, slowly moving you more into bonds, which are less risky investments, as you near retirement.
"The target-date fund is going to be the best option for most people. It's simple — you can buy it and forget about it," Blanchett said. "It offers asset allocation and everything you need."
If your 401(k) plan offers target-date funds, simply find the fund with a date that is closest to when you think you might retire. If you're 35 and want to retire at 65, go with a 2045 target-date fund.
If target-date funds aren't a choice, you'll want to pick a balanced fund. They typically hold a mix of stocks and bonds.
You'll likely have a few different options with varying degrees of risk. In general, higher-risk funds allow for greater returns, while lower-risk funds typically have lower returns but with much less volatility.
You can look to your employer for help researching these options.
A survey by human resources consulting firm Mercer found that 79% of retirement plan participants said their employer offered advice on their plan.
It also found that those who sought advice reported more confidence in their retirement than those who didn't.
Start by talking to your boss, benefits administrator or human resources department.
They won't have all of the answers, but they'll at least be able to let you know what support or services are available.
"Generally, larger companies do more on the education front and have somewhere to get advice," said Christine Benz, director of personal finance for the investment research firm Morningstar.
Some companies offer customized websites that help you learn how to better use your 401(k).
They take into considerations things like age, income, other assets, expenses and risk tolerance to provide automated fund recommendations from the available options in your plan.
Some will even use models to forecast how much you could have in your account by retirement. You'll be able to change contribution rates and investment options to see what the numbers could look like.
Also, look to websites like Morningstar, which produces some of the most commonly used fund ratings and has links to prospectuses and other detailed fund information.
While mulling your investment options, you'll also want to take a look at fees.
You can't control the fees charged by the firm your company picked to manage your 401(k), but you do have some control over the fees you'll pay on the mutual funds you pick.
A good rule of thumb is to never buy a mutual fund that charges more than 1% a year. This is often referred to as the expense ratio.
Most target-date and index funds charge much less than that.
Fees can drain tens of thousands of dollars from your nest egg over the years.
A single percentage point doesn't sound like a lot, but it is.
"One percent can be a huge difference when you factor in the effect of compounding. You really need to look at the fees. It's not that (your employer) is out to get you, it's that some have better plans than others," said Odean.
You should be able to obtain all of this information from your plan administrator.
Finally, you'll want to manage your 401(k) as a part of your overall portfolio. So any outside IRA or other investments should be factored into your total asset allocation.
Consider consulting a financial adviser.
With proper advice, you'll be able to write a custom-tailored road map to get from where you are now to the retirement you want.
Unless you have a tremendous amount of money, Blanchett recommends a fee-based planner. A session might set you back $200, but you'll get impartial, independent advice.
The planner will be able to take a cumulative look at your finances and tell you how to best proceed with your 401(k).
"It could help to get a planner's take to find out more about your options. They'll be able to step back and look at your 401(k) options as a part of your entire financial picture," Blanchett said.
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