401(k)

Posted by Tad Johnson - Feb 6th, 2008 at 15:02

401k1.jpgSo named from the section of tax law from which it came, this investment vehicle is a way for both you and your employer to save on taxes while you save for retirement. It has become a very popular option among employers, with many making it an automatic decision for new employees.It’s an easy way to save, but it’s not fool-proof. You are responsible for setting up your 401(k) and deciding what investments you want to make. Here’s what you need to know to take full advantage of your 401(k):

1. Take full advantage of employer match. Ask your HR department for information regarding the company match for the 401(k). Many companies will match 50-100% of your contributions, up to a set limit. For example, my company offers a 50% match up to a total of 4% of my income. So for me to take full advantage, I need to direct 8% of my income to my 401(k). This should be a no-brainer. If you don’t take advantage of your company match, you’re leaving money on the table.

2. Don’t put too many eggs in the company basket. Most 401(k) plans offer company stock as one of the investment options. Think twice before investing a significant portion of your 401(k) in company stock. Simply by being employed, you are investing in your company’s future. Keep your retirement investments separate so you won’t be devastated if your company falls on hard times. Use the rule of thumb that no more than 10% of your retirement savings should be in your company’s stock.

3. Consider your age when choosing investment options. Most 401(k) plans offer a wide variety of investment options with very different risk and return profiles. (The two go hand in hand; higher risk = higher return) As a vicenarian, risk can be your best friend. You have 30+ years before retirement, giving you plenty of time to weather any storms the stock market throws at you. Consider investing the bulk of your 401(k) in stock-based mutual funds, including plenty of international stocks. Although stocks will have up years and down, their overall trend for the past 80 years has been up, with an impressive average return of 8%.

With some basic planning and steady savings, you’ll have a comfortable retirement.

Your investment’s worst enemy : you

Posted by Tad Johnson - Feb 4th, 2008 at 5:02

Your brain is not well equipped to handle the task of investing. Don’t feel bad about it, mine is to. In fact, everyone’s brain is bad at investing. We seem to get the whole long-term/short-term thing screwed up, and we’re not terribly good with risk vs. reward.used-car-salesman1.jpg

Ask any investor who has sold just as the market starts to go up or bought at the peak of a rise. (I’ve done both).

You can easily compensate for the brain’s biological limitations by establishing an investing plan. Force your self to use the long-term planning part of your brain to write down (yes, really) your plan for the year and share it (yes, really) with a trusted friend. Your plan should include details like:

  • Monthly savings goals
  • A short list of the assets you want to buy
  • Monthly (or quarterly) investment schemes

Here’s an example for Bob, a vicenarian:

I will save $200/month, directing 50% to a US index fund, 35% to a global index fund, and 15% to a consumer staples mutual fund.

With this plan, Bob can automatically deduct the same amount from his paycheck each month and instruct his stock broker to automatically invest the same amount every month. This is called dollar cost averaging, and it smooths out all the ups & downs in the market. Such a plan saves you from making poor decisions based on fear.

Consider the scenario where the market drops 5% in a week. Bob panics and he’s tempted to sell his stocks. Fortunately, he has made the plan above and talks to Alice (his trusted friend). Together, they come to the conclusion that the market probably isn’t on the verge of collapse. Instead, Bob continues his regular investment plan and is pleasantly surprised when the market finishes the month 5% ahead of where it started. Not only did Bob avoid making a hasty sale, but he actually benefited from the brief drop by buying more shares at a lower price.

This sort of long-term planning isn’t difficult, but following through can be. Rest assured, prudent investment planning and execution will lead to consistent, safe returns over the long run.

Mutual fund secrets

Posted by Tad Johnson - Feb 2nd, 2008 at 19:02

Over the past decades, mutual funds have gained immense popularity. Most investors now own shares in one or more mutual funds, and virtually all 401(k) plans include mutual fund choices.

The allure of the mutual fund is clear: it allows the individual investor to purchase a share in many different companies and take advantage of the expertise of the investment banks who offer them.

As with all things in life, this is not a free lunch. Mutual fund managers are paid [well] and these payments come directly from you, the investor. Most funds simply take a percentage of assets right off the top each year. This is called the expense ratio, and is generally between 0.5 and 3%. This may seem insignificant, but it’s crucial that you understand and compare the expenses when choosing a fund. Over a long period of time (like the 30+ years until you retire) a difference of even 0.5% can make a huge difference.

Why are some funds more expensive than others? In theory, the best performing funds will charge (and justify) the highest expense ratios. Index funds–those that aim to match the performance of one of the large benchmark indices–generally charge a low rate. Specialty funds and those that actively try to beat the market will charge more.

For the young investor with decades to go before retirement, the goal should be finding funds that perform well with low expense ratios. Fidelity and Vanguard are both known for low-cost funds. Fidelity’s S&P 500 index fund (FSMKX) charges a mere 0.1%; Vanguard’s similar index fund (VFINX) is almost as low with a 0.15% expense ratio. Aim for 0.5% as a goal for all of your funds, and be wary if you’re paying more than 1%.

Retirement : not just for old people

Posted by Tad Johnson - Jan 14th, 2008 at 19:01

retirement.jpgYou’re young, you’ve worked hard to graduate from college and land your first job. Congratulations! Having just started a career, retirement is likely the farthest from your mind. That’s something that your parents have to think about.

So do you.

You will thank yourself later if you take the time to set up a retirement plan now and start saving. Consider: $20 invested today will grow to $200 after 30 years, and almost $500 after 40. Time is on your side! And unlike your parents, you have at your disposal a number of easy investment choices and some great benefits from Uncle Sam. With a small investment in time, and a small percentage taken from your paychecks, you can be on the road to retirement with financial security.

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