New Employee 401(k) Decisions

You graduated last spring.  Spent your summer finding that first job.   Planning for retirement doesn’t seem like a very high priority, not compared with getting a handle on your student loan payments, furnishing that new apartment, or making  your car payment.  Still, a little time spent sifting through your retirement account options will pay real dividends towards your future financial security.

T. Rowe Price, an investment company, demonstrated in an article titled, “Savings: The Simple Key to Retirement Income,”  that if you put $100/money aside starting at age 22 and then stop at age 32, you will have more saved for your eventual retirement then someone that starts saving for retirement at age 32 and puts $100/month aside from age 32 to age 65. (The comparison assumes that both investors earn 7% annually and that the money is held in a tax deferred account – like a 401(k).)

Free Money!

If your employer offers matching contributions to your 401(k) plan, then not taking advantage of those options is like throwing away free money.  The typical company match is 50¢ on the dollar up to 6 percent of salary.  You contribute 6%, the company contributes 3%,  you’ve made fifty percent on your money instantly.  At some employers you have to stay with the employer long enough for the employer contributions to vest before they’re yours to keep.

Default Choices

Many 401(k) plans now offers a default investment choice to employees that don’t pick out their own investments.   The default choice is typically a target date retirement fund which will invest your contributions with an investment (planning) horizon approximately equal to your Social Security full retirement age, which is for millennials, and anyone born after 1960, age 67.   Is the default choice right for you?  It’s not a bad place to start, especially if you can’t find other options the 401(k) plan offers that you like better.

Other Investment Choices

My  general rule is starting out in a 401(k) plan you want to concentrate your investments in well diversified investments rather than diversify your investments across multiple accounts.  There may be an annual account fee charged for every mutual fund you invest in, and those fees can add up, especially when you’re just starting out.   One or two mutual funds that are broadly diversified in their asset classes and have low annual expense ratios should do the trick.

You have to decide whether you’re trying to beat the market or be the market.  Beat the market strategies are called active management.  For you to earn higher returns with an active approach you have to earn more than the market return, net of fees, and actively managed fees are higher than the fees on passively managed, or market index funds.  Since the market, on average, earns an average return, the typical employee will be better off with a passive approach to investing his or her 401(k) contributions.

The mainstream asset classes are: cash, bonds, and stocks.  Since a retirement account during your working years doesn’t have much need for liquidity, cash needs are minimal for passive investors. Active investors may try to time the market shifting investments to cash when they feel stock or bond market prices are headed south.

Other Fees

Employers used to focus more on minimizing their costs of administering the 401(k) plan than on your costs and investment choices within the plan.  Employers are now required to provide documentation detailing the plan’s costs to the employee.  Keeping fees and expenses in mind in deciding how to invest your 401(k) contributions can reduce the drag on the yield in your retirement account.

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