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The Best And Worst 401(k) Strategies

The Best And Worst 401k Strategies

More than 41 million U.S. households have at least one family member with a 401(k) plan. As of early 2018, the average balance of a 401(k) account was $102,900, and the total amount of 401(k) assets was more than $5.3 trillion.

Retirement investment accounts are a great way to plan for the future, but there are right and wrong ways to go about using a 401(k) account.

Best: Considering Risk Tolerance

Investing can be as safe or as risky as the investor wants depending on their strategy and goals for the future. Smart 401(k) investors consider factors such as age, years until retirement and retirement sum goals in determining how much risk to take.

As 401(k) investors approach retirement age, they should typically be scaling down on higher-risk investments like growth stocks and shifting allocation toward lower-risk investments like U.S. Treasury bonds.

Worst: Not Contributing To A 401(k) Plan

Not every American has access to a 401(k) plan, but a recent study by the Plan Sponsor Society of America found that 15% of Americans who are eligible for a 401(k) still choose not to contribute.

Not only do many companies have 401(k) contribution matching, 401(k) accounts offer tax incentives that can compound retirement savings over time. The earlier Americans start contributing, the larger an effect these compounding benefits will have.

Best: Buying Low-Cost Stock Index Funds

The stock market can be extremely volatile and unpredictable in the short-term, but the S&P 500 has been remarkably consistent over longer periods. Despite a number of market booms and busts — World War II, the Great Depression, the Great Recession and any number of major economic disruptions — the 30-year rolling annual return of the S&P 500 has always stayed between roughly 8% and 15%.

Low-cost S&P 500 index ETFs like the VANGUARD IX FUN/S&P 500 ETF SHS NEW (NYSE: VOO) provide the lowest-cost exposure to a diversified investment in the U.S. stock market.

Worst: Relying On Your Own Company’s Stock

No matter how much you love your boss and how much business is booming, it’s never a good idea to rely too much on your company’s stock to fund your retirement account.

Having a small amount of your company’s stock in a 401(k) account is fine, but too much exposure to a single company creates too much long-term risk.

Just five years ago, a company like General Electric Company (NYSE: GE) seemed like a low-risk retirement investment, yet the stock is down 58.8% in the meantime.

Best: Considering A Roth 401(k)

Roth 401(k) accounts are tax-deferred, meaning contributions are not taxed until they are withdrawn in retirement. For Americans who anticipate they will be earning less income in retirement than they are right now, Roth 401(k) accounts can both ease the overall tax burden on contributions and allow contributors to benefit from pre-tax capital gains on their contributions.

Roth 401(k) accounts aren’t optimal for all Americans, but they are the preferred route for most savers.

Worst: Not Maxing Out Employer Matching

On Wall Street, there’s an adage that says there’s no such thing as a free lunch. Yet employer 401(k) matching is as close to a free lunch as Americans are going to get.

Companies with matching plans typically offer to match 50% of all 401(k) contributions up to 6% of an employee's salary, or some similar structure. Make no mistake about it — these matched funds are free money from your company. Not maximizing these matching contributions is simply leaving free money on the table.

Best: Diversifying Your Portfolio

The best way to maximize returns while minimizing your risks is to diversify your 401(k) investments as much as possible among stocks, bonds, commodities and other assets. A general rule of thumb among financial planners: allocate no more than 110 to 120 minus your age to stocks.

For example, a 35-year-old retirement saver can have up to 85% of his or her 401(k) devoted to stocks, whereas a 50-year-old should have no more than 70% of the 401(k) account in the stock market.

Worst: Holding Cash

Cash can play an important role in your overall financial health, but it has no place in a 401(k) account. Cash is great for near-term spending and easy access in case of an emergency, but early withdrawal penalties disqualify it from serving this role in a 401(k) account.

Instead, cash in a 401(k) account is drawing little or no interest while inflation eats away at its value. Instead of holding cash in a 401(k) account, keep it in an easily accessible high-yield savings or cash account. Cash in a 401(k) account should at least be invested in low-risk assets, such as U.S. Treasury bonds.

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