Now, read the title of this post carefully! It says take free money from your boss. I’m not saying steal from your boss, which is a great way to get fired and/or arrested. But yes, many of you already have or will have an employer who is willing to give you money for free, even if he or she in other ways makes the Grinch look generous.
I am of course referring to your 401(k) plan, for those of you living in the USA. No, advice like “participate in your company’s 401(k)” is not new or earth shattering, so most of this post will involve what to do with your 401(k), which is something you won’t necessarily find on a gillion other websites. For those of you outside the USA, a 401(k) is a type of retirement savings plan offered by most companies in America.
First, let’s get the obvious stuff out of the way. You’ve undoubtedly heard this before: participate in your company’s 401(k), and contribute as much as you can to it. I won’t argue with that, but I would like to emphasize the “as much as you can part”. This means, don’t overextend yourself just to participate in a 401(k). Don’t put your ability to pay rent on time or buy food in jeopardy, and if you have credit card or other types of debt, allocate at least some of your income to paying it down, and some to your 401(k) plan. Be reasonable. If you have to start off slowly, and increase your allocation over time, it’s not a bad idea; in fact, it’s a great idea!
So where does the free money come into play? For those of you not familiar with 401(k) plans, I’ll explain: often, your employer will match a portion of the contribution you make to the plan. For example, your plan might have a 100% match into your account up to 3% of your income, or it might match 100% for the first 2% or your income, and 50% for the next 2%, etc.. Looking at the former, if you make $50,000 per year and contribute 3% of your income to the plan, it amounts to $1,500 that you put into your account annually, but your employer matches it with another $1,500 going into your account. This equals $1,500 per year in free money!
There are also tax benefits to participating in your 401(k), which I’ll get into at a later time. I’d rather spend the rest of this post talking about things you won’t necessarily hear in other places, which is what to do with the money in your 401(k) account.
Asset allocation is the subject for an entire post just by itself, or even the whole chapter of a book. I’ll post more about it in the near future, but I’ll also make a few comments about it today. It’s a general principle of investing that stocks in general are riskier than bonds, so the more risk you want to take in your 401(k) account, the more you should have allocated to stocks, and vice versa.
Again, nothing revolutionary. But another general principle that I’m not completely sold on is that the younger you are, the more risk you should take, because you have more time to get losses back than someone closer to retirement. My preference is that you only take the level of risk you are comfortable with no matter what age you are. When we’re talking about money that could be building and compounding on itself for several decades (which is one of the points of this type of plan), I’d prefer you don’t get too crazy with it at any age.
When it comes to risk in a 401(k), there are a few safeguards built in, so it’s pretty difficult to go off the deep end of risk even if you want to. But I’ve seen some pretty unfortunate things happen when people got a little too greedy with their plan. I had a friend who, against my strenuous advice, put 100% of his plan allocation in a NASDAQ index fund, right before the market collapsed and took 2/3rds of his portfolio along with it. Ouch.
The risk safeguards that I refer to are due to the fact that 401(k) plans have a set lineup of investment options, the overwhelmingly vast majority of which are mutual funds. You can still get hurt by making poor choices (see the paragraph above), but it’s not like you can put all of your money on a hot stock 2 weeks before they head to bankruptcy court like you can in other types of investment accounts.
Here is what I think is a smart way to build your 401(k): use the core/satellite approach that I talk about rather frequently. Start with index mutual funds. A large cap index fund, or total stock market fund, accompanied by an international total stock market fund, and total bond market fund, make up a great core. Adding in a small cap index fund, and maybe even a real estate index fund, adds some diversification and makes for an even better core. See my recent post on how to pick solid index funds if you haven’t already read it.
Now for the satellite portion. I will be talking a lot more about building core/satellite portfolios in the very near future, so I’ll just make a few brief comments here. The “satellite” portion of your account could be made up of actively-managed mutual funds rather than index funds; actively managed meaning there is a manager or management team deciding which stocks to buy and sell, rather than the fund just trying to match a particular index. I like to use active funds in the “value” and “growth” style categories only.
It looks like I’m going to have to create a “part 2” to this post later this week, in the interest of not going too long today. Stay tuned; more very soon, I promise!
Commentaires