Picking the right funds for your retirement account is critical, but so is understanding how to maximize your savings. Here's what you can do to keep more of your money.
The biggest risk to investment accounts is performance. If the market tanks, the stock-based mutual funds in your 401k account are likely to decline, as well. If bond yields remain paltry, any bond fund you own will suffer. That's the way investing works.
But a retirement-investing strategy focused exclusively on performance also carries risks that can cost you money, even in Wall Street's good times.
That's because attention to the fees and logistics of your 401k or IRA plan can be just as important as picking the right places to put your money.
And investors who don't read the fine print or perform regular portfolio maintenance can see their retirement accounts languish, even if they have the right funds picked out.
Start by making sure you are fully taking advantage of the match your employer offers. It's free money, as long as you take the initiative to ask for it.
The rules differ among employers, but the bottom line is that you should take what's offered. If your company offers 100% on the first 3% of pay you contribute, set aside 3%. If your company offers a 50% match on the first 6%, take all 6%.
You might be reluctant to "reduce your salary," but this is the wrong way of thinking. In truth, you are giving yourself a raise. Yes, if you make $50,000 annually, a 6% contribution moves $3,000 of spending money each year into your 401k. But don't forget that your employer will be giving you an extra $1,500 above your salary with that aforementioned 50% match.
You have to save for retirement anyway, so why say no to an extra $1,500?
The most obvious charges that 401k investors have to endure are the "expense ratios" of their mutual funds. You might have seen these on your portfolio documents and just shrugged them off. After all, what's the big deal about a 1% fee?
If you think that way, think again. Little fees add up fast. In real terms, that 1% fee gets shaved off your 401k account each year.
Let's look at a practical example. Say you invest $3,000 per year in your 401k and average a 5% annual return. In 30 years, with compound interest, you'll have a nest egg of about $210,000. But if you have to give up just half a percentage point and average only 4.5% annual returns, the final amount in 30 years will be just more than $190,000. That's $20,000, or almost 10%, shaved off the final amount.
Expense ratio matters.
Expense ratios are the easiest thing to watch, but don't think that's the end of the story. Responsible investors need to do a bit of detective work if they expect to plug the leaks in their retirement plans.
Most companies are required by law to report fees and expenses of their employee benefit plans. This commonly is found on the "transaction history" or a similarly labeled section of 401k statements. If you see a small dollar amount withdrawn or partial shares taken out, an administrative fee is the likely culprit.
If you can't find any fees in the transaction history on your account statement, your human resources department should be able to get you an ERISA filing -- short for Employee Retirement Income Security Act. This law requires fees to be logged in some manner.
Sometimes the fees are baffling, such as those that vary according to the amount of money in an account. And administrative fees can't be avoided in instances where an employer makes just a single 401k provider available to its employees.
If your fund options are limited or the fees seem too steep, it might be time to consider alternatives to 401k's for at least some of your retirement savings.
The practice of "rebalancing" your 401k is tricky, because it involves assessing how your portfolio has changed over time and moving the money around to best suit your retirement goals. Because of how different mutual funds perform, your 401k might become unbalanced without you even noticing.
Think of it this way: You have $10,000 in a fast-moving stock fund and $10,000 in a low-risk bond fund. Your goal is to be allocated 50-50 between the two. Well, if the bond market is flat and your stock fund goes up 50%, you now have $15,000 in stocks and $10,000 in bonds. You're now 60-40.
So what do you do? You rebalance. Take $2,500 out of your stock fund and transfer it into bonds so you can return to a 50-50 mix.
This is a key part of risk management, because over time you might not notice that the lion's share of your portfolio is in risky, fast-moving investments. It's a good problem to have, of course, that one part of your portfolio has grown so fast. But if you don't move that money around, you could expose yourself to disaster if things turn the other way.
There's a catch, though: Some 401k plans have a cap on the number of transfers you can perform annually. If you exceed that number, you might have to pay a fee. So while rebalancing is important, it shouldn't be overdone.
A good rule is to rebalance once a year, at tax time, with the help of your accountant or financial adviser, if you have one.
The hard reality of the current economic environment is that many people have had to tap their 401k's to make ends meet. But this should be your last resort.
For starters, if you withdraw money before age 59½, it not only will be taxed, but you'll also absorb a 10% early-withdrawal penalty. (There are limited exceptions to this.) So all that hard work you put in to save will be offset by steep charges for taking money out early.
Also, removing $10,000 now can cut much more than $10,000 out of your total nest egg. A 5% average return annually will turn that $10,000 into more than $16,000 in 10 years. Presuming your 401k performance is good, you are forfeiting the potential profits you'll generate with this investment in addition to the principal.
Never take a loan from your 401k plan or cash out early if you can avoid it. Depending on your circumstances, it might make more sense to put a few thousand bucks on a credit card or take out a home equity loan than to eat into your nest egg.
So think things through before raiding your retirement fund. The penalties are steep.
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