Tuesday, December 7, 2010

10 Easy Steps to Enriching Your 401(k) Experience

It seems as if the topic of 401(k) investing is surfacing quite often. The young are starting to establish a plan with their employer and the "old" are beginning to worry if their 401(k) is working in the best way possible for them. Truth is, a lot of individuals don't get the most out of their plan. Either, they are too afraid to invest in equities so they let the funds accumulate in the money market account available within the plan or are way too aggressive by investing in one segment of the market.

Ironically, people spend hours upon hours researching their next car (depreciating asset) or the new, coolest computer. What if that same time was spent educating yourself about your 401(k)? You could use your knowledge to not only make your investments work better for you, but to educate the trustees responsible for servicing the plan to get a better one - now we're talking!

You worked hard for that money, you earned every single cent of it. How come I see 401(k)s that are half of what they were ten years ago, or just simply haven't moved? It has nothing to do with the market, the market certainly provided healthy returns over the past 10 years.

Simply put, people just aren't educated about investing, especially within their 401(k). The beauty of it is, the warehouse worker can become more educated than the CEO, creating a better investment experience for him/herself just because the warehouse worker did a little bit of homework. This research, in most cases, can be a difference of millions of dollars. Yes, millions, for a little bit of time and know-how! My plan is to give EVERYONE several easy steps that they can utilize within their 401(k)...for FREE! Put that in your back pocket. Here we go.

1. Participate. Your company is without a doubt giving you a great deal! If you don't participate, you don't reap the benefits. You should contribute as much as you can afford, especially if your employer matches - it's free money. Also, you can usually set it up so that automatic deductions are taken out of your paycheck and put into your 401(k). You don't even have to think about.

2. Invest the funds appropriately. Here is where we see the biggest mistakes made. You want to find the lowest cost funds. Academic studies show that the funds with the best performance have the lowest expense ratios - duh! Do not invest in a fund that has an expense ratio over 1%. Try and find funds that have expense ratios in the .08% to .6% range. Once you have found low-cost funds, you should begin to put the puzzle together. You want to find these asset class (what markets they are invested in):

US Large-Cap, US Large-Cap Value, US Small-Cap, US Small-Cap Value

International Large-Cap, International Large-Cap Value, International Small-Cap, International Small-Cap Value, and Emerging Markets.

Just make a check-list and cross them off as you find each one.

If you can find funds with "index fund" within the name, perfect, these are your best bet! Ideally, your plan will most likely not have all of the aforementioned funds (poor plan). To do something about this see Step #8.

3. Determine your allocation.
Simply said, how much will you allocate to equities and bonds. Equities will earn you a greater return, but with more risk. Bonds, the opposite. To determine your allocation here is a quick rule-of-thumb: Take your age, subtract the number from 110, the number you get is about the percentage you need to invest in all of your equity funds. Obviously, a much younger investor (21), could handle putting all of their funds in equities. Like I said, this a quick rule-of-thumb.

An example: You are 40 years old. You subtract 40 from 110, equaling 70. Roughly 70% of your overall funds should be invested in equities. Now, half of that 70%, 35%, we will split up equally among your 4 US funds mentioned in Step #2. The other 35% will be split up equally, five-ways into your International and Emerging Markets funds. Obviously, the other 30% of the overall plan will be put into the bond fund. You are almost off to the races!

4. Rebalance your funds once a year. Generally speaking, since you have your percentage or allocation figured out via our quick rule-of-thumb, this number should be your target every year. In our previous example, our target should be to maintain a mix of 70/30 (Equities/Bonds). The individual funds you invest in will move, up or down. Each year, rebalance the funds so that your allocations are appropriate, both your equity/bond allocation, and your allocations within the equity funds. This quick exercise will keep your assets aligned and on the way to your goals. Plus, some plans even allow you to select an auto-rebalancer. Even better, you don't have to check it, unless of course you get older, in which case your equity allocation will go down.

5. Don't invest your plan assets in the company you work for. This step is fairly obvious, but I have seen people's fortunes get wiped out for making this mistake (Citigroup, Enron, etc.). No matter how big, tough, and great your company is, do not invest in your own company. This is called double exposure or career risk - you wouldn't stand on top of a hole you are digging right?

6. Do not borrow against your 401(k) savings. Some plans allow individuals to borrow against their funds for certain situations. This is not a good idea.

For an example, if for any reason you cease to be an employee at your company, the entire balance of the loan becomes due and payable immediately. If you don’t pay, you will have to pay taxes (plus a 10 percent penalty if you are under 59 ½ years old) on the loan balance. This means that if you are laid off, you will suddenly have to pay back this loan – just at the time you may be the least able to afford it. This among other reasons, show that it is unwise to borrow against your savings.

7. Know thy plan.
Reading your plan documents doesn't sound like fun, especially when Monday Night Football or the Victoria Secret Fashion Show is on. But again, your education will earn you a substantial amount of money over the long haul. Get to know what you can and can't do within the plan. Who is in charge? What are the fees? Knowledge is power here! If you can't figure out what a term means, ask H.R. at your company.

8. Educate the trustees of the plan.
Again, it is your money. If the investment options I mentioned are not available, your plan is not good enough. Try and persuade the plan trustees to include low-cost index funds in the plan. Keep in mind, the trustees usually have their assets in the plan as well, so what helps you, helps them. You are a tribe. Refer the trustee to our website or blog so they can become educated. Remember, from reading your plan documents you will know who is in charge and responsible. The trustees usually hold a fiduciary standard to the plan. So, if you point out that the current plan is sub-par and they can get better, and they don't get a better plan - Uh oh...somebody may be in trouble, just saying.

9. If you do leave your employer, get your moolah.
Tax laws will hurt you if you aren't familiar with what happens when you leave your workplace. Bottom line: Once you leave your job get your money within 60 days, roll it over into a Rollover IRA (a professional advisor can help you here). Two things: You will have better investment options within a Rollover IRA and if you don't roll it over and instead, decide to go shopping with the money, you will be taxed by the IRS 20%, and possibly a 10% penalty. All at your current tax rate - not fun!

Example: If you have $60,000 in your IRA when you leave your job and ask for the money in cash, the employer pays $12,000 to the IRS and gives you a check for $48,000. You can invest that $48,000 into a Rollover IRA, without tax consequences. But unless you also invest another $12,000, the IRS will tax you (and possibly also penalize you 10 percent) on the $12,000 that you had withheld. It doesn’t seem right or fair, but that’s the law.

10. Upon retirement, create a plan. You have made it this far, you need a plan to maintain your standard of living after work. A professional will be able to help you in this area. The professional can transfer the funds to a better investment solution for you. Take this part seriously. Find a fee-only, independent advisor. Someone who will take fiduciary responsibility for your money. The advisor should only be paid by you, no one else. Are they going to sell you a product or choose the best solution for you? Make sure to ask them these questions. Again, important decisions will translate into millions earned or lost. The last thing you want to happen is to realize you do not have enough to support your lifestyle and end up having to go back to work. Talk about a loser.

That's it! Any person can follow the 10 steps. They are easy and simple. If you put in the time to read this article, you will be successful at maintaining a disciplined approach. Do not try and time the market within your plan. Stick to your guns (funds) and rebalance - that's it. This a portion of your life where you have complete control, whether it is taking the time to read your plan documents or persuading your CFO for change, the decision is a vital and a beneficial one. Please help others and pass this article along. In 10 to 30 years people will thank you for enriching their lives, both financially and emotionally.

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