401ks are often a mysterious thing, set off to the side without much care to it – especially if they are automatic contributions being made. Once it is set, you really never have to look it again…right? Unfortunately, that really is not the case. Planning for retirement is a continuous process, and leaving it for the last minute is really not the best idea.
Daunting as it may seem, 401ks are not as complicated as they are made out to be. There are several ways to craft a strategy that will ensure that you are getting the most out of your contributions. You should also consider working with an accounting or personal finance professional who is able to give you sound guidance and help formulate a 401k plan that makes sense for your budget.
In the meantime though, here are 3 quick and simple ways to start a 401k strategy and see what it can do for you.
1) Do not cash out
This may sound simple or redundant, but it is probably the most important point of all. Many employees are tempted to cash out, especially as job switching becomes more common. Although you will likely switch employers during the course of your career, resist the temptation to cash out. That money is for your retirement, plain and simple. To use it for anything else is taking a risk for no reason, and you lose a valuable nest egg in the process. A 401k will not be able to do much for you if there is not anything in it to begin with.
Also keep in mind that workers who decide to withdraw from their 401k before the age of 59 will face an early withdrawal penalty. This is usually about ten percent, and you will also have to pay income tax on the amount withdrawn. Withdrawing early also means that you will lose out on valuable compound interest that is essential for building a retirement fund.
2) Don’t always use the default savings rate
Usually when employers set up a 401k account, the default settings are usually what end up being used throughout. However, it is better to be active about this and make sure that you are not just stuck on default rates. The rates are usually at about three percent, which does not amount to much for someone trying to build a solid retirement fund. Evaluate your forecasted retirement expenses, and pick a savings rate that will help you pay those bills rather than sticking with a low amount that might leave you struggling.
3) Research the right mutual fund for you
Contributing is the first step in the process, but finding the right mutual fund is the second and perhaps most important step. A 401k is really only as good as what you choose to invest in, and is important to be savvy about your options. For investing in the stock market, a safe bet is usually a whole-market (also referred to as a “total market” index fund, or S&P 500 index fund.
According to an article by The Motley Fool, “index mutual funds simply attempt to match the performance of the overall market by buying the stocks in a specified index. That doesn’t sound too exciting, but matching the index is a thrill when you consider that 80% of actively managed mutual funds (i.e., mutual funds that pay a team of analysts to pick stocks) have historically underperformed the index.”
Ultimately, 401ks may start off confusing but it will become easier the more you engage and understand exactly how it works – and what you can gain out of it. Using it wisely, and staving off any temptation to use cash from it quick and easy is the best way to start maximizing it. Once you are more comfortable with understanding where your investments could potentially take you, it may be wise to work with a professional to ensure you are employing the right strategies to get the most out of your 401k.