[401K] Educate me

I have to admit that I don't know much about investing nor have I yet started a 401k at my job. Is there anything I should look out for? What percentage do you put in monthly?

A 401K plan is a retirement plan that you fund yourself. It can be in combination with or a replacement for a traditional pension. Your employer will probably add some money to the 401K as a percentage of your salary. I get 1% without any action on my part. This may or may not be a "match" to money you contribute yourself. I contribute 5% and my employer contributes an additonal 4% match. You can contribute up to 14% from your paycheck, not including matching. All of this comes out of your paycheck before taxes. You will have to pay taxes when you withdraw the money (usually at retirement). The tax rate used will be straight income, unfortunately, and not capital gains.

You will have choices in how to invest this money. I suggest doing some homework here. It could mean the difference between retiring with 90 grand or 300 grand. Look at the stock mutual funds. Those that are diversified and have not lagged the S&P 500 Index are what you are looking for. I would strongly suggest avoiding company stock. This is way too risky, unless you get some awesome deal on it.

If you have more than 5 years until retirement, put everything in this mutual fund. This is controversial, but my opinion. When you get within 5 years, start moving some of the money towards bonds or Treasury bonds.

The most important advice I can give is to contribute at least enough to get that match from your employer. For me, it is 5%. Don't leave that money on the table, you'll regret it.

The 401K with matching can be the best investment you ever make. Think of it as getting 100% profit the first day plus whatever interest or stock growth you happen to get.

If there is a match, invest the max starting today.

The money is generally tied up till you retire. If you need it before you reach 59 and 1/2 years old you can take it but you will pay your normal tax rate plus a penalty. Is the penalty still 10 percent fed, 2 percent state? I have not looked in a while.

Some companies require that the match is made in company stock. If this happens, it's a good idea to convert it when you can. Your income is already tied to the health of the company, so your retirement should be elsewhere.

Daniel

Well I don't know what else to add to the above posts, other than to reiterate what they have said. I am just guessing that you are fairly young, so you probably have some time to make a decision, but the sooner the better. You could start small and build it slowly. You should start by at least taking any free money you can get by contributing the max amount that is matched. So say if the company match is 50 percent of the first 5 percent that you contribute, then start with that 5 percent. Now since that 5 percent is pre tax dollars, it will not lower your take home pay the full 5 percent. It will be less than that, so you probably won't even notice the lesser amount in your check. Then whenever you get a raise, bump up your contribution a percent point or two. So now you are painlessly saving for your future and getting free money. What could be Better?

Now where to invest that money. Chances are you will have several choices of funds available to you inside the plan. You will want to read up on those choices of course. But remember to stay diversified. This is what makes index funds ideal. By investing in index funds you are diversified automatically. If you invest in say a S+P 500 index fund you are in essence buying stock in 500 of the top U.S. companies. I like index funds because of the diversifacation they offer, the fees that all funds charge are less with index funds, and very few actively managed funds have out performed the S+P in the long term. I would also put say 20 or 30 percent in foriegn funds. So that would be my advice to a person just starting out.

You may have a no-brainer choice available to you as well. These are retirement target funds that are managed for retirement dates. So you can pick one that is right for you. The fund automatically diversifies the mix of stocks and bonds in it based on your retirement date. They start out more aggresive and slowly shift over the years to a more conservitive mix.

After a while goes by and you have amassed a sizable sum in your account you will become more interested in learning about stocks, money, and investing. The thing is just to get started now. Keep it simple to begin with. But start today by at least getting that FREE MONEY I talked about.

Now that you got me started, sorry I can't help myself, But I think 401k's are best thing since sliced bread. I've got a couple of other things to say.

In general 401k's allow you to take advantage of one other importent investing strategy known as dollar cost averaging. By making fixed amount, regularly scheduled investments in your funds you will be buying more shares when they are cheaper and of course less shares when they are more expensive. The perfect and smart way to invest. And it's automatic.

Don't be greedy. Do not chase after high returns, you will most likely lose. When looking at funds you are better off going for a "Steady Eddy" than todays high flyer. It can be hard to pass on a fund that shows very high returns over a short period, but remember that it is high because it has already, or is about to peak, and it will most likely be flat or downhill from then on. By investing in the high flyer you will be buying at it's peak. Then when it goes south and you tire of losing money and get out, you will have bought high and sold low. Not smart, but it can be a very hard temptation to resist. In every prospectus, for every fund, there is a line that says something to the effect of "Past performance is no gaurantee of future performance." No truer words were ever spoken.

Now for the good news, if you are in your 20's or early 30's and you make an average amount of money, with just a little effort on your part you could easily be a millionare by the time you retire. Just do it!

I max mine out all the way.

But there's one risk that no one has talked about and that risk is that you might be at a higher marginal income tax rate when you retire. If that happens, you would have been better off not deferring any income and just invest it outside of a qualified plan. Let's say you are at the income tax rate of 33% today. You save your money in a 401(k) and when you retire, the tax rate you're in is at 70%. Well you just deferred your income just to pay higher taxes on it. It's not a likely scenario since the presumption is that you will be at a lower rate when you retire but for some people that have amassed a great deal of wealth, it's a possibility. Just look at the historical marginal tax rates in the US. In the 1970's, the top tax rate was 70%. It's been trending slowly downward since then, along with the national debt trending waaaaaaaaay up. Guess who's gonna pay that debt :thinking: It's not going to vaporize and we (tax payers of the great United States) have to pay the piper for the sins of the gubement. In any case, contribute to the extent that you get the maximum match from the employer.

Good point, but don't you only get taxed on the amount you withdraw?

Wow, that is great reading. When most of you talk about investing, I'm assuming this is when I retire and take the money out, correct? There is no investing the 401k while it's simmering in that huge pot?

Not sure exactly what your question is. When you stick money into your 401k you are investing. 401k is simply a name for a retirement investment vehicle that is named after section 401k of the tax code. Inside your 401k you will have different options on where to invest this money. You could put some into stock mutual funds, some into bond funds, maybe some into your company stock (although as noted before that is not really a good choice). And you may have other choices as well, every company's 401k's options are different. For instance let's say your company uses T. Rowe Price (a well known brokerage firm) to administer the 401k. You would probably have a choice of something like 7 or 8 funds, out of the hundreds of funds that T. Rowe Price offers, that you could invest in. You could invest in one, two or all eight of them. But the point is all of those that are offered to you are under your 401k umbrella. So you are investing. See, you are practally a tycoon already!

This money will be taxed at whatever the going rate is as you withdraw it upon your retirement. This money is meant for retirement only. If you borrow it back, (Which you can do) or take it out before retirement you will immediatly owe taxes and some major financial penalties. Only under the most dire circumstances would you want to prematurely withdraw it.

Arkayne said:

Wow, that is great reading. When most of you talk about investing, I'm assuming this is when I retire and take the money out, correct? There is no investing the 401k while it's simmering in that huge pot?

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When you put the money in your 401k, you are already investing. You should have a choice of several mutual funds that you can put your money in. Putting money into a fund through a 401K is investing just the same as if you sent the money directly to the fund. The main difference is that your company has done some of the work already. They've already narrowed down your choices somewhat, they've decided on who is administering the plan and paying them, and to top it off they're giving you some free money. At a minimum, you should participate however much you need to in order to get the full matching amount. Otherwise, your throwing money away.

I have a book recommendation for you.
http://www.amazon.com/gp/product/097418585X/qid=1067445423/sr=8-1/ref=sr_8_1/102-6868511-5791351?n=507846&v=glance
It is written by a local financial adviser in my area who I have listened to on local radio for years. It doesn't give any specific advice on how to pick stocks or mutual funds. It is more of an explanation of how investing works by relating often difficult financial theories to more ordinary subjects that are readily understandable. For example, when discussing natural stock market cycles he relates it to how the same cycles occurred in grain, pigs, and beer back when these were the common things being traded. Although there are one or two spots where he drifts off into financial speak and starts slinging a bunch of numbers, most of the book is plain english and the stories are entertaining. I found it to be a very easy read and I normally stick to Sci-Fi books exclusively. I think his early education as a cultural anthropologist gave him a unique way of looking at the financial world in terms of how it reflects the behaviour of people. This book is more about teaching the proper mindset needed to make good investing decisions than about teaching the technical details of investing.

On Taxes;

The US taxes are tiered. If you only make a few thousand there are no taxes. If you make 200,000 you pay a higher percentage.

The 401 K is not just handed to you at 59.5 years. You withdraw it a little at a time or as needed. Let's say you retire at 60 years old while making $65K, but your house and cars are paid for so you only need $40K a year to enjoy life. That's alll you withdraw that year and your tax rate will be less than the year before. If you take out another $20K to buy a new car, that money is taxed at the 40-60k rate.

If you withdraw your money in large chunks, the taxes will get you, but that's always true of large payments.


The devil in retirement planning is that you can not predict the variables. The government may change the rules. The economy may tank. The state of medicine may progress to the point where you live 50 years longer than you planned. Inflation may devalue your savings. A crooked CEO or accountaint may steal it all.

Even so, I'd rather plan for the future rather than spend it all now and hope for the best.

Daniel

Make an appointment with a financial institution. Edward Jones, who handles my parents financial stuff, gave me a free 2.5 hour meeting, which could have gone on longer, but we both knew it was overwhelming me. And it was VERY eye opening. After the meeting, I decided to move my savings account from my local bank, to a Money Market account through them. It acts like my existing savings account, but I can write check from it, and it earns around 4%, compared to my horrible saving account's .25%

At the time of the meeting, I had $15,XXX in my bank's savings acount. That gave me around $3.XX a month interest(.25%), so say $36 a year in interest.
With the MM account, I'd get around $500 a year in interest(at 4%). That's $500 FREE money every year. And that figure was only based on what was in the account at that specific moment in time. After the next weeks paycheck, and the one after that, and after that..... I'm a big fan of free money.

I also contribute heavily to my 401k. My company matches 1/2, up to 3%. So I have 6% of my check in my 401k, to get my company's max of 1/2, which is 3%. So between $40-60 goes into the 401k from me every 2 weeks, then another $20-30 free money from the company's match.
The advisor showed me something awesome about the 401k, where the investment grows exponentially. It doubles itself every 9 years. So the eariler you invest, the quicker and more powerfully the money grows. At the meeting I had $5000 in the 401k, and if I had never invested anything more into it ever, it'd STILL grow to around $300,000 by the time I was in my 60s. If I had started investing in my 30s and 40s, I'd have to put 2 or 3 times the amount to make it to $300,000.

So save early and often! And go talk to someone in a suit whom you can trust.:laughing:

Tooner said:

Inside your 401k you will have different options on where to invest this money.

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Bingo! I thought I had to wait until retirement to pull it out and invest it into something else.

Again, thank you so much for the help and recommendations!

Arkayne, my local bank helped me start investing outside my 401k, with Mutal Funds. Since the money in my bank account wasn't earning squat at 4% interest, I had moved a large chunk into thier Mutal Funds. That money was totally accessable, without any penalties, at anytime. So everytime my savings broke the $10,000 mark, I'd put the excess into the mutual funds. But if something bad went down, or I needed to draw a large amount of money at the drop of a hat, I had the option of just moving however much money back into my savings/checking account without any penalty or fee. You may want to talk to your bank's Branch Manager about Mutual Funds or bonds. That way all your money is under one roof, in a sense. It made me feel comfortable, knowing that.

Omega Man said:

Arkayne, my local bank helped me start investing outside my 401k, with Mutal Funds. Since the money in my bank account wasn't earning squat at 4% interest, I had moved a large chunk into thier Mutal Funds. That money was totally accessable, without any penalties, at anytime. So everytime my savings broke the $10,000 mark, I'd put the excess into the mutual funds. But if something bad went down, or I needed to draw a large amount of money at the drop of a hat, I had the option of just moving however much money back into my savings/checking account without any penalty or fee. You may want to talk to your bank's Branch Manager about Mutual Funds or bonds. That way all your money is under one roof, in a sense. It made me feel comfortable, knowing that.

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Great tip, I'm heading to my bank at lunch and will look into that.

EDIT: The university I work for is a State/Federal employer and offers a 403B or supplemental 457. No matching here

BugOutGear_USA said:

Good point, but don't you only get taxed on the amount you withdraw?

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That is correct. But let's say you were a great saver (some of us are good at socking away money). Under today's rule, you have to make mandatory withdrawals at age 70 IIRC and the withdrawal is a percentage of the total value of the account. You may end up having to withdraw an amount that puts you into a higher marginal tax rate. What's really eye opening is the historical income tax rates. Google that and you'll see that income taxes have trended downward at least from the 1960's. The rate we're spending, that trend just absolutely cannot continue and I see income taxes rising. I'm not discouraging anyone from putting money in a 401(k) but it does not come without the risk I'm talking about. Like someone said above, the gubement may decide to change rules on us just as we're about to draw from that large stash of $$$. The way things are going, it's a more likely scenario than not. Until the United States gets its fiscal *** in order (ie, get out of debt), I'm pessismistic about our future.

CM, what you are talking about occurred to me after a few years of contributing 10% (the max at the time). I had been getting very good results from investing in my own taxable portfolio, way beyond the S&P 500.

I figured that the tax "savings" of my 401K would be offset by the lower returns of the S&P500 Index fund that was my only choice and the higher tax bracket that I expect to be in when I retire.

I cut back my contribution to 5%, to get the match, and invest the leftover cash from my paycheck in my personal stock portfolio. My taxable portfolio is growing much, much faster than my 401K, and the tax bite should be a lot less--long term capital gains, offset by my capital losses that I take on my losers.

My retirement should be a 30 year party. This strategy isn't for 99.9% of people though.

Lightraven said:

...and the higher tax bracket that I expect to be in when I retire...

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Interesting you say that. It's contrary to most people's expectations, except for you and me of course But like you say, this does not work for most people, especially those that save a moderate amount or those that save late in the game. I'm maxed out artificially well below the usual limit for most people on my 401(k) but if I didn't have the cap imposed on me, I'd go all out. I also invest post tax a great deal more than my 401(k) will allow due to the risk that I mention above. But as you said, it's not a strategy that is appropriate for most people.

Expect the sp500 to double in value about every 6-7 years.

Take your average return (say 12% for the sp500). Divide that into 72. This gives the # of years till your money doubles. 72/12=6

Also, FEES have not been mentioned. They have have an ENORMOUS cumulative effect on your $.

I invest through vanguard.com They charge me .18% for fees. And that will drop to .09% when I get 100k in there. Please notice the decimals in these figures. Typical broker/investment houses charge 2-5%. That's a LOT of difference. That means YOUR investment has to beat mine by 1.8-4.8% just to give you the same returns.

Any long term investment should be made in an index fund. So far, no mutual fund has beat the sp500 average over a long period of time.

Also, inflation averages 3.5% historically. That means that in 20 years, the value of your $ is HALF of what it appears to be.

To find inflation value:
(1.035^Y)^-1
Where Y is years.
(1.035^15)^-1

So 15 years from now, a dollar will be worth $.60


Also, once you begin to draw from your investments, they must be able to reinvest and grow by 3.5% to keep up with inflation, or your purchasing power will begin to drop. This means that your conservation 8% investment will only return a USABLE (8-3.5) 4.5% return. And this is BEFORE tax.

When is the best time to invest? It is the same best time to plant a tree.

10 years ago.

When is the 2nd best time?

Today.

Omega Man said:

Make an appointment with a financial institution. Edward Jones, who handles my parents financial stuff, gave me a free 2.5 hour meeting, which could have gone on longer, but we both knew it was overwhelming me. And it was VERY eye opening. After the meeting, I decided to move my savings account from my local bank, to a Money Market account through them. It acts like my existing savings account, but I can write check from it, and it earns around 4%, compared to my horrible saving account's .25%

At the time of the meeting, I had $15,XXX in my bank's savings acount. That gave me around $3.XX a month interest(.25%), so say $36 a year in interest.
With the MM account, I'd get around $500 a year in interest(at 4%). That's $500 FREE money every year. And that figure was only based on what was in the account at that specific moment in time. After the next weeks paycheck, and the one after that, and after that..... I'm a big fan of free money.

I also contribute heavily to my 401k. My company matches 1/2, up to 3%. So I have 6% of my check in my 401k, to get my company's max of 1/2, which is 3%. So between $40-60 goes into the 401k from me every 2 weeks, then another $20-30 free money from the company's match.
The advisor showed me something awesome about the 401k, where the investment grows exponentially. It doubles itself every 9 years. So the eariler you invest, the quicker and more powerfully the money grows. At the meeting I had $5000 in the 401k, and if I had never invested anything more into it ever, it'd STILL grow to around $300,000 by the time I was in my 60s. If I had started investing in my 30s and 40s, I'd have to put 2 or 3 times the amount to make it to $300,000.

So save early and often! And go talk to someone in a suit whom you can trust.:laughing:

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Something to think about since we're all talking about money.

My wife and I funded our daughter's retirement.

She is 2 years old and has $6k in a vanguard sp500 fund.

That should rise to 4.2M at age 60, neglecting inflation.

If you have kids, it's something to think about.