Do You Want to Retire Early? How About Retiring Wealthy? Read This For Insights
Jan 06 '00
401K plan or savings account? I am a financial advisor and can give you some of the ideas that we utilize and why they are so important to your future financial well being.
First of all, the answer is pretty straightforward; You should always participate in your 401K if you have the option. The more you can contribute the better. Why? Most companies will provide a match- meaning for every dollar you put in they will put in a certain amount up to a set percentage of your salary- and this is free money. For instance, if you contribute $1.00 your company may contribute $.50. Yes, I know, this does not sound like a lot, but when your are talking about $10,000 the numbers add up quickly. Would you turn down a person who was offering you $.50? I would hope not! If you do not contribute you are essentially turning free money.
Secondly, even if you work for a company that does not contribute, you should contribute as much as you possibly can. You need to look out for your financial future and by saving in a vehicle that makes it difficult for you take your money out you are taking the first step. There are ways to get your money without penalty (buying a new home and certain hardships), but the should not be considered.
Thirdly, another advantage to a 401K plan is that the money grows without the overhang of taxes. What do I mean? When you sell an investment outside of a tax advantaged account you will pay taxes and that diminishes you actual return. In a tax advantaged account the taxes are not incurred until you pull the money out, when presumably, you will be in a lower tax bracket. Additionally, the money has many years to grow without paying taxes, which means that your full investment is growing, rather than what is left over after taxes.
Finally, another advantage is that you can dollar cost average. When you dollar cost average you do not care what the market does. You will contribute a fixed amount from each paycheck and if the market is down you will buy more shares. If the market is up you will buy fewer shares. The bottom line is that a 401K is a long term investment and all that really matters is that the account is not at the lows when it comes time for you to need the money. In fact, in a perfect world, you want the market to be down for the remainder of the time that you will contribute and then take off to the upside as you near retirement.
So who should utilize a 401K plan and how? Anyone who is working and has the opportunity should use the plan. Be aware that if you will need the money before retirement you will pay a penalty- one thing to consider when deciding how much to invest. My general feeling is that you should be aggressive when investing in a fund for the long term. What I mean is, set your account so that you are fully invested in stocks or equity funds if you have a period of five years or more until retirement. If you have a shorter horizon you may consider shifting a portion of your principal to a less aggressive fund- money market or bonds. However, remember that people live to much older ages these days, so you want to be sure to have a decent amount of capital growing in stock funds.
A final word of caution; remember to diversify. Often times we see our company and know that they are doing well so we buy a lot of the company's stock. Great idea, but remember that a shock can from anywhere and often will come from where you least expect it to come from. Once the shock comes the decline in your 401K balance can be swift and brutal. The decline can also last for quite awhile.
In summary, I would suggest investing the maximum amount that you can in a 401k plan. Skip the savings account altogether! A savings account should be used for emergency money only, and for small amounts of emergency money only.
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