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Financial Literacy Month Q&A: Maximizing Your 401(k)

April 09, 2015, 8:56am posted by  |  0 comments

Posted in: Financial Literacy Month, CK Authors, Ben Murray,

This post is part of our celebration of Financial Literacy Month this April.

Most people understand that preparing for retirement by contributing to a 401(k) account is generally a good thing. But when it comes to actually doing it, confusion can kick in. When should you start? How much should you contribute? How should you monitor and manage your 401(k)?

In the spirit of Financial Literacy Month, we connected with our friend JoanAnn Natola, Managing Partner at Element Financial Group, to clear up some common areas of uncertainty. She shared advice for how to truly maximize your 401(k). Check it out below.

CK: When should you start contributing money to your 401(k)?

JN: The short answer is: if you would like to retire some day, you should start saving for retirement as soon as possible. Time is your most valuable contributor to retirement savings because investment returns compound over time. Remember, however, that if you do not start early it is always a good time to get the party started!

Additionally, keep in mind that saving when you are young means you have decades to earn compounding returns. A dollar saved at age 25 is worth about $20 at age 65. And it’s good to remember that it will be harder to save once you have obligations like kids and a mortgage, so try to get ahead now.

CK: How should you determine how much to contribute to your 401(k)?

JN: Contribute as much as you possibly can. Your first priority should be to contribute to a 401(k) up to the employer match because it’s free money. Why?  Free money is free money – take it. Next, a good rule of thumb is between 10-15% of your income.

CK: How should you determine how conservatively or aggressively to allocate funds in your 401(k)? 

JN: Investing is risky and there’s no guarantee you will finish with more money than you started. But consider the alternative: inflation rates are at three percent and if you’re keeping your savings in cash, you will lose significant purchasing power over time. Luckily there is a better way. 

If you need help determining how to invest and your risk tolerance, resources are available. Many 401(k) platforms will provide an investor questionnaire to help you access your asset allocation based on information you enter about your investment objectives and experience, time horizon, risk tolerance and financial situation. Many generic questionnaires are also available on the internet.

When it comes to deciding how much to invest in the stock fund versus the bond fund, a general rule of thumb is to invest 100 minus your age in stocks and the rest in bonds. But that is extremely general and changes for individuals, based on risk tolerance and financials.

CK: How often should you adjust your contributions to your 401(k)?

JN: As your financial circumstances or goals change, it may be helpful to adjust your contributions to your 401(k). Additionally, if you plan your investment objectives and contribution goals in advance, many 401(k) platforms allow you to automatically increase your contribution annually by a specified percentage. Therefore, if your plan is to contribute 15 percent of your compensation but you can only afford 10 percent this year, your best bet is to have a contribution strategy to increase your deferral by one percent annually on an automatic basis. I recommend you do so at review time, when most people receive their raise in salary. This way, you generally never miss that additional one percent and you are nicely rewarded at retirement time!

CK: What are some of the most common misconceptions about 401(k)s?

JN: The basic goal about retirement planning in general is pretty straightforward: to replace the income we had during our working years with income from the assets we have saved for retirement. Simply put, we aim to replace one income stream with another, thereby allowing us to maintain our lifestyle. A common misconception is that Social Security income – even in a supplementary way – will be available to ensure this replacement of income.

Another usual misconception is that once you start, you are locked into a permanent deferral strategy and cannot change your contribution amounts. 401(k) salary deferrals are completely voluntary and can be stopped, started or changed (subject to your plan administrative rules) at any time.

Finally, the most common misconception is that to start your 401(k) you must be great at investing. There are rarely right or wrong answers in investing, only better or worse decisions. Most plans have terrific fund menus that allow for many options for new investors or the sophisticated do-it-yourselfer!

For more information on JoanAnn Natola and Element Financial Group, head to www.elementfinancialgroup.com

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