Many people seem to forget that pensions aren’t what they used to be. Employers no longer foot the whole bill on the average American’s retirement, but fortunately we do have the 401k, and that allows people to make their retirement as comfortable as they possibly can. There are several ways of ensuring this, and the most important ones are to maximize and manipulate the account. I’m speaking from the position of a federal employee, but the rules are pretty much the same across the board.
In the beginning, it is important to jump on board as early as possible and give ’til it hurts. The money made early on is the most important because it will be foundation of the account. In (let’s say) a duration of twenty-five years, that first $1000 invested will make many times more than the initial donation. Keep this in mind when you aren’t making the maximum investment because you want to be able to afford this year’s vacation. Stay at home now and see the world when you retire if that’s the case. It’ll be well worth the wait! If things are tough in the beginning of your tenure, be sure to at least invest enough to be able to draw the full employer donation. In the federal service, the government gives 1% regardless of your contribution. The agency matches the first 3% and then gives 50 cents on your dollar up to a maximum employer donation of 5%. That should be motivation enough!
The risk factor of the account should fall in line with the number of years the employee has until retirement. A new contributor should never play it safe and invest in government bonds with a 4.something% rate of return. The Dow, international stocks, and small business stocks will fluctuate, and there will be many moments when you will wish you had all your money in the safe area. In the long run, though, the risky investments in a 401k roughly follow the S&P 500. This has grown tremendously over the years, in spite of brief hiccups along the way. The key is diversification. The federal TSP has an investment called Life Cycle Funds. They are automatic and adjust as one nears retirement. Why? A risky investment in the 24th year of a 25 year tenure can cost the contributor hundreds of dollars a month when retired. That’s when you want most of your account locked into a 4-5% sure thing.
Follow these simple rules, and NEVER borrow from the fund. In a worst case scenario, borrow from a bank (or even a loan shark!) because it will cost less than what you’ll lose by playing around with a 401K. These are powerful investments, and a large enough contribution could see the retiree drawing interest off of hundreds of thousands of dollars. With that said, my last piece of advice is to roll the account over upon retirement. Don’t siphon funds off of the principle; that, too, will cost you in the end.