For many employed Americans, the 401(k) has replaced the pension as the primary source of their retirement savings. In many cases, it represents their entire retirement savings, so it's important to make sure it is performing at a level that will provide the nest egg you're hoping for.
Most of us just assume that when it comes to our 401(k), everything is all right. Each pay period, our company takes out a percentage of pre-tax wages, possibly matches the contribution, and deposits it into our 401(k) account. But how often do we check that account to make sure the return is what you were expecting? What? You said "never."
You're not alone. In the business they call it "inertia." Before 401(k) contributions became automatic "inertia" was considered the main culprit keeping employees from signing up. Today, 401(k) contributions are usually automatic. That same inertia now has more workers contributing to 401(k) plans because if you do nothing money is automatically deducted from your pay and deposited in a 401(k) account. To get out of it you have to take action, and most people don't. Now the problem with inertia is that people remain too complacent when it comes to what that money is invested in.
You should know that by next year it will be easier to figure out how much your plan is charging you, whether that fund you're pouring money into each month is still aligned with your goals, and who you can turn to for investment advice. But until then, you have to do the digging yourself.
Start by making sure you have a plan that fits your personality, whether you need hand-holding or prefer to go it alone. If your plan falls short, talk to your boss to see if he or she can improve it. A few small changes in how you save and invest your money today can make a huge difference in your future nest egg.
Here are some other key questions:
Q: Is my 401(k) is any good?
Your plan should offer a well-diversified mix of low-cost investment choices. An employer match is a plus because employees tend to save more when their company kicks in money. Investment guidance and regular, personalized report cards to show you whether you're on track are important parts of a great 401(k) plan.
Q: What's the right investment mix?
Make sure your investment mix matches your risk tolerance. Most plans have funds that range from aggressive-growth funds to income funds for those employees near retirement.
Q: How much of your salary should you save?
Probably more than you're saving now. Most employees are saving 7% a year or less, and employers are offering matching contributions of another 3-4% of pay. That adds up to about 10% which isn't going to be enough. Try to save about 15% of your gross salary, including any employer contribution.
Karen Blumenthal of The Wall Street Journal offers five common 401(k) mistakes and adjustments you can make to keep your retirement plans on track:
Mistake No. 1: Thinking the most important decision is how you invest your money.
Many of us agonize over selecting just the right funds or whether to put 50% or 65% into stocks. Sure, asset allocation can have an impact on your bottom line, though it is partly a game of luck, depending on whether you catch a rally in one sector or another. Your first priority, though, should be determining how much you need to save"and figuring out how to make that happen.
Unfortunately, compared with debating mutual funds, savings "is so unsexy that nobody wants to talk about it," says Mike Alfred, chief executive of Brightscope Inc., which rates 401(k) plans.
The average participant saves 7% to 8% of pay, but many retirement-plan advisers recommend you aim for 10% or more, before including your employer match. Under Internal Revenue Service rules, you can contribute as much as $16,500 to your 401(k) this year, plus an additional $5,500 if you are 50 or older. If you want to be more exact, try using an online financial-planning tool, such as the Economic Security Planner (basic.esplanner.com).
Mistake No. 2: Investing only enough to get the company match.
You don't want to leave any money on the table, so you definitely want to collect whatever the company is offering. But in reality, it may not be that great a deal. Some companies eliminated the match in the last downturn, and many haven't restored it.
Much more common"and much less discussed"is that many companies make that match hard to collect. Matches take up to six years to vest at 60% of the companies surveyed by the Profit Sharing/401k Council and half of those surveyed by Hewitt Associates, a human-resources consulting firm that recently became Aon Hewitt, a unit of Aon. In some cases, you may not receive any of the match for as long as three years, or you may get only a fraction of the match each year for six years.
Given the uncertain job market, it can be dicey to count on collecting your share. Instead, save for your future and maximize the tax advantage of contributing to the plan.
Mistake No. 3: Assuming your 401(k) can be invested for you alone because it is for your retirement.
If you are married, don't assume your investments are just for you. Many people choose investments without weighing what their spouse is doing or what other stocks or bonds they own. Retirement-planning software offered by many firms rarely ask how other family funds are invested.
Yet all of your savings will play a role in your future comfort. So at least once a year, you should put your investments and your spouse's together and make adjustments. If your spouse's plan has better international-fund options, your spouse could invest more heavily in those while you put more in bonds. If you haven't done this before, you may find it as much an exercise in trust as in investing.
Mistake No. 4: Investing too much in your company's stock"even after Enron and Lehman Brothers.
Last year, just 17% of companies matched employee contributions with company stock, down from 36% in 2005, according a survey by Hewitt. In addition, employees today can usually diversify those shares at any time; in 2005, more than half of the plans didn't offer that flexibility.
Still, Hewitt found that when company stock was an option, 21% of retirement-plan holdings were invested in it, an exceedingly large allocation to a single stock.
If you have ignored your company-stock holdings, now may be the time to diversify. Vanguard recommends that your company stock shouldn't make up more than 10% of your retirement-plan money.
Mistake No. 5: Picking funds based on performance alone.
Stock and bond returns are largely unpredictable. But the one factor that is predictable is the expense rate. When deciding which funds to invest in, zero in on the ones with the lowest expenses.
The impact could surprise you. A recent Hewitt analysis found that cutting investment fees by 25 basis points"or $25 per $10,000 investment"could have the same effect as receiving an extra half-percentage-point match from your employer over your career
