While most people can agree that saving for retirement is the most crucial financial move they will make, there is little consensus on the best way to achieve this. If you are a full-time employee, chances are you have an employer 401(k) available to you.
But just having the account available is not enough. Not only do you need to enroll in the plan, but you will also need to choose your contribution amount and investment options. While it may sound simple, there are many factors you should consider.
Here are some important steps to take before investing your 401(k):
Read the Summary Plan Description
The Employee Retirement Income Security Act (ERISA) requires plan administrators to provide participants with the most important facts they need to know about their retirement plan. This document is also known as the Summary Plan Description (SPD).
Some important questions that are answered in the SPD are:
- Is there a minimum age requirement to participate in the plan?
- Is there a minimum service requirement to participate in the plan?
- Do you make contributions to the plan, or do all contributions come from your employer?
- Does the plan allow rollover contributions from other plans?
- How are employer and employee contributions invested?
- When do you become vested in the retirement plan?
- Are you allowed to borrow from your retirement account?
Determine your risk tolerance
Before investing, it’s a good idea to determine how much risk you are comfortable with. When it comes to investing in the stock market, there is always a risk that your investment could decrease. Depending on when you plan on retiring or withdrawing any money can determine how risky your investments should be.
Typically, the longer your time horizon (i.e., 40 years until you retire), the more risk you can tolerate. If you are nearing retirement, it’s usually a good idea to have a more conservative allocation. While everyone’s situation is unique, it’s important to understand your risk tolerance and update it as your needs and plans change.
Review your investment options
When it comes to your 401(k), you will usually have a list of investments to choose from. This means that you can’t invest in individual stocks or any type of investment fund.
Your investment options will contain different categories of investments, such as U.S. large cap funds, international funds, bond funds, or target date funds. Each category invests in different types of companies and has its own risk. You will want to work with a Certified Financial Planner to help you determine the appropriate investment options to support your risk tolerance, goals, and time horizon.
Check the expense ratios
A very important factor when selecting your investment options is to review the expense ratios for each fund. Expense ratios are the fees carried by the investments. Depending on your investment options, these fees can be as low as 0.04% or as high as 1.2%.
While you cannot predict what will happen in the stock market, one of the few things you can control is the fees that you pay. Choosing investments that have lower expense ratios can help increase your returns over time.
To put this in perspective, let’s assume you invested $100,000 for 30 years and have two similar funds to choose from, Fund A and Fund B. Both funds will return an average of 8% annual return. Fund A has an expense ratio of 0.1% and Fund B has an expense ratio of 0.6%. If you chose Fund A, you could have over $135,000 more just by paying the lower expense ratio.
Saving for retirement is one of the most important financial decisions that you can make in your life. If you would like to work with a financial planner to walk you through your options, I would love to help you!
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Disclaimer: This blog is for informational purposes only, and should not be considered advice or recommendations. All opinions expressed herein are solely those of Amaral Financial Planning, LLC, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made to another parties’ informational accuracy or completeness. You should consult your financial advisor, tax professional or legal counsel prior to implementation.