Saturday, September 19, 2009

Your 401(k): The Odds are Not in Your Favor yet...

It is common knowledge that your 401(k) is not being used correctly. Statistics show that you are probably not going to retire wealthy. The Social Security Administration has found that about 5% of those invested in such plans actually attain the goals they set out to reach. According to the SSA, about a third of you will leave whatever you accumulate to your heirs in part because by the time you reach eligibility you will be dead. A surprising amount of you (estimated at 54%) will not have invested enough over your working years to make any impact on your post-work life.

These odds of a financially secure retirement using a 401(k) seem to be not in your favor. Yet, there are ways you can improve your odds without too much effort on your part (which is good considering those 34% who never make it to retirement may have failed because of the stress of trying too hard to do too much).

You need to do three things:
First is start early enough in your working career to make the plan work for you. Age is the biggest factor in your retirement success, Time allows your plan to go through the numerous corrections that these plans need in order to function properly.

Markets have ups and downs. because you add a fixed amount each paycheck, you cannot buy more when the markets are expensive; instead you buy more when the markets are cheap. A steady stream of cash headed into these plans (pretax) basically ensures that you will have far more invested than those who spend a good deal of time trying to beat the market, time the market or otherwise trying to outsmart the market.

If you begin investing later in your career, you will have to set aside substantially more than your younger counterpart. Once you commit to this, do not adjust your contribution downward. Instead, look to your personal financial world to make budgetary adjustments. Fixing debt issues, getting your mortgage to a reasonable rate that will show a zero balance when you do retire, and living on a fixed income (long before it is actually fixed) all will help you reach the rarefied air of financially secure.

Second is a little more complicated: how much is enough? The question of how much you put away depends on many factors. But one thing is certain, five percent minimum will not alter your take home pay. Will that give you enough?

Folks will use the innumerable calculators found online to try and determine how much they will need. The correct way to make these assumptions is not in the total amount you might have accumulated but in the amount of money you will need to withdraw once you retire. Four percent per year will, in almost every circumstance, allow you to never outlive your money. And that is the goal. If you can safely say that the 4% mark is enough based on the way you are contributing, you will be fine. If not, it is time to step it up a notch. Time is wasting.

(If you company has suspended or eliminated their matching contribution, do not stop investing.)

Third is more complicated still: where to put your money? This is well-discussed yet in many conversations, misses the mark. Index funds, found in almost every 401(k) have low fees and low-risk. What you want is low fees and enough risk to grow that money.

Your 401(k) is a tax-deferred plan, meaning you pay the taxes later in life when it is assumed that you will be earning less and in a lower tax bracket. Why then would you want a tax-efficient fund in your plan? This kind of investing will be counterproductive to your goals. Spread your investment dollar over a series of investments in your plan, diversifying among growth (large-cap, mid-cap, and small-cap) and funds that offer some out-of-the-country exposure (it is a global economy that doesn't always act the same way domestic market do - they can actually do better).

Fees (what your mutual funds charge to invest for you and sometimes what your plan sponsors charges for the paperwork they do) however are what most folks should look at more closely. Most plans are flawed in this respect. If you are a small company employee, you may be able to get your plan changed. Larger companies move much more slowly and often do not respond to the wishes of a small group. But you can try and encourage your co-workers to do so as well.

Time, steady contributions and a close eye on the cost of your fund are some of the key elements in your retirement success. And it all relies on you doing something for your future.

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