Have you just opened a new 401k? Had one for a while, but have no idea what do with it? This guide is for you. Learn how to manage your 401k and what to invest in to actually make money safely.
401k’s have become the most common way to save for retirement. Most companies offer them today in place of the long gone pensions our grandparents used.
As a millennial, maybe you’ve just graduated and started your career and you were given access to invest in a company sponsored 401K. Maybe you’ve been working a while and have already signed up, but didn’t really know what to do with it. Either way this guide will get you started making money in your 401k safely.
Boring But Essential Tax Info to Know
401k’s are a great investment because the money you add to your 401K is not taxed. However, you will have to pay taxes when you withdraw from them and will be taxed a 10% penalty if you withdraw prior to becoming 59 ½ years old. If you have a Roth 401K, it works a bit differently. You don’t get the tax relief up front, but will get to withdraw tax free when you do finally pull money from your 401k.
Grab the 401k Cheat Sheet below! Print it out, tape it to your office wall, keep it on your desk. Whatever works for you! Know exactly what to do to make the most out of your 401k.
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Contribute Enough to Your 401k to Get Your Company Match
Most companies offer some type of match if you contribute to your 401K. If you’re not taking advantage of this free money you should! You’ll have to talk to your HR department to give your specifics for your company.
You contribute 6% and the company will also contribute 6%
You contribute 6% and the company will contribute 3%
You contribute 3% and the company will also contribute 3%
You can always contribute more than 3% or 6% but you should at least contribute what is required to get your company's match otherwise you’ll basically just throwing that money away.
Over time that money will grow significantly and you’ll have lost a tremendous amount of future money. I highly suggest putting at least 10% of your income into your 401k.
So, for example, if your company matches your 6% contribution with a 3% employer contribution, try putting 7% in and with the company match of 3%, this will be a total of 10% of your income into your 401k. That’s a great start to building a retirement nest egg.
One of the best features of a 401k’s besides the tax advantages is the fact that the payments are automatically withdrawn before you are paid and invested. You won’t even notice the money is missing. It’s an awesome way to do automated investing!
Increase Your Contributions to Your 401k When You Get a Raise
Another great way to increase your contribution is to apply any new income you gain from a pay raise to your contribution in your 401k. This works really well because you never even see the increase, so you never miss the bigger paychecks. If you do this with each raise, it will increase your retirement funds dramatically over time.
Now, I realize if you are already struggling this may be difficult. Maybe you need the extra income. That’s OK.
Let’s say you get a 3% raise. You could add 1% to your 401k and allow the rest to be add to your paychecks. A little bit is better than nothing and totally worth it.
Be Aware of Your 401k’s Vested Balance Before Switching Jobs
You may not know that the portion of the money your company is adding to your 401k is most likely not yours yet. They call this the vested portion. It’s just a fancy word for owned.
This means that the portion that your company is adding to your 401k is owned by them until you have worked at the company for a certain amount of years. It’s common to see the company own the portion they add for 3 years before allowing you to keep it even if you switch jobs.
After that time period the though, the money is yours to keep. The idea is to keep you from leaving the company quickly and taking that money with you. It’s a way for them to try to get you to stay a bit longer at the company.
If you're thinking of switching jobs early, take a look at your 401k vested balance and determine if that job is worth giving up that 401k money. If you don’t know how many years you have to remain at the company to own all the money, check with your HR department. They will be able to tell you.
Invest in Low Cost ETF’s (Exchange Traded Funds) in Your 401k
Once you’ve got contributions going into your 401k, it’s time to invest in something that will actually make you money.
The best option you can put your money into is a low fee ETF of the S&P 500.
So, why should you invest in a ETF instead of a mutual fund or individual stocks?
1 - Fee’s
ETF’s have low fees! Extremely low. Funds like Vanguard have an average fee of .12% Compared to a mutual fund can cost you up to 2%. This doesn’t sound like a lot, but it can add up over time especially when you start to build up large amounts of investments in these funds.
2 - Diversification
You can’t get much more diversified than a ETF of the S&P 500 index. This covers basically the entire stock market! It’s 500 of the largest companies on the stock market.
If you buy a stock from one company, you are relying on that one company to do well. If it goes bust or has a hardship, you’ve lost all or a huge part of your investment money.
If you buy a mutual fund, not only are you paying ridiculously high fees to an overpaid fund manager, but you’re only investing in a pool of companies that the fund manager decides on. Statistically most fund managers can’t even beat the S&P 500 index so why would you pay them those high cost fees?
3 - Auto Pilot
ETF’s are a great hands off investment. They are basically like investing in the entire stock market. You buy and just wait. No need to adjust your portfolio or sell.
By setting up automatic contributions from your paycheck it will use the dollar cost average strategy. What’s that?
Dollar cost average is buying the ETF as it goes up and down in price. When the stock market is not doing so well, you are getting it at a lower price. When the price goes up you gain. You’ll be doing this through all the dips and rises. It’s a great way to invest on autopilot.
Contribute More to Your 401k Once You’ve Met Your Other Financial Goals
Once you’re contributing 10% and getting your company match I recommend focusing on other financial priorities before contributing much more.
If you haven’t already seen it, read my article: 10 Steps to Gain Control of Your Money and Grow Rich.
Make sure you’ve completed other financial goals like:
Eliminating all your debt other than your mortgage
Contributing 5% of your income to a Roth IRA
Contributing 5% of your income to a personal investment account
Building up at least 3 - 6 months of living expenses
Once you’ve completed those goals, you can begin adding even more to your 401k. As of 2017 you can contribute up to $18,000 dollars into your 401k. That’s $1500 per month.
This option is only for those who are already in a very stable financial position and have a high income with significant free cash flow. You most likely are not there now, but it is very likely as you further your career and gain more income over time you could get to this situation at some point.
Watch Your 401k Grow
So you’ve got your contributions setup to automatically deduct from your paycheck. You’re getting your company match. You’re investing at least 10% of your income. You’re working towards being totally vested in your account or already are. You’re investing in a low fee ETF of the S&P 500 Index.
Now you can sit back and watch it grow. If you don’t already have a financial app to track your investments, you should get one. Two great financial tracking apps are Mint and Personal Capital.
Mint - www.mint.com
Personal Capital - www.personalcapital.com
I highly recommend signing up for one of these services which are free and adding your 401k account. This will allow you to see your 401k balance from your phone or from their website and get some great insights into how they are performing.
If you are fully utilizing the app it will add your 401k to all of your other financial accounts and give you a total net worth.
You can learn more about that here in this guide: The Complete Money Picture System.
Contribute enough to your 401k to get your company match
Understand your vested balance
Contribute at least 10% of your income
Invest in low fee S&P 500 ETF’s
- Sign up for a financial tracking app to keep an eye on your 401k balance
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