How to choose the best investments for your 401k plans
Employer-sponsored 401k plans are one of the best benefits available to employees. Because the money you contribute is deducted from your gross income before the taxes are paid, no tax will be levied on the money you entered. The fund’s capital continues to grow with deferred taxes until it receives distributions, and many employers contribute additional funds to their contribution, which some call “free money.”
For example, some employers contribute up to 6% of an employee’s salary on a dollar-for-dollar basis, up to the amount of the employee’s contribution. If you earn $ 50,000 per year and set aside 10% of your salary in your 401k ($ 5, 000), in this scenario your employer would contribute an additional $ 3,000 (6% of $ 50,000), increasing your total investment at $ 8,000. This is an important benefit that substantially accelerates capital growth.
Investing $ 5, 000 per year for 20 years with a growth rate of 5% results in a fund of $ 104, 493; Investing $ 8, 000 during the same period in the same yield produces a fund of $ 167, 188. The final balance is a combination of the money you invest and the rate of return you earn with your investment over time. With this in mind, you must work to maximize your contributions, including the corresponding contribution from your employer, by selecting the investments that will help you achieve your retirement goals.
Tips to choose the best investments 401k
Determining which investments are the “best” investments is not a “one size fits all” effort. Everyone starts saving at different ages, with different goals, different income and expenses, and different retirement expectations. All these factors affect the investments that are most likely to be adapted to your particular needs. Your decision may be further complicated by the investment options available to your employer.
By law, 401k plans that allow you to select your own investments must offer at least three diversified options, each with different risks and returns. In general, it is not allowed to invest in collectibles, such as art, antiques, gems or coins, but in certain circumstances you can invest in a precious metal, such as gold. These are not usually recommended for retirement plans, since they do not obtain a standard yield, but fluctuate in price depending on the psychology of the investor and the industrial value.
1. Your level of investment
At a minimum, you must invest, at least, at the level of your employer’s matching contribution. In 2014, you can contribute up to $ 17,500 (or $ 23,000 if you are 50 or older), with a maximum contribution of $ 52,000 (including the combination of your contribution and your employer’s contribution). It is easier for most people to divide the annual contributions into equal parts deducted in each pay period. For example, if you want to contribute $ 12,000 a year, you would request that $ 1, 000 of your salary be deducted each month.
The best advice for anyone saving for retirement is to invest early and often. Saving early in life maximizes the benefit of tax-free capitalization. Consider the example of Mike and Tom:
Both Mike and Tom earn the same 5% interest rate on their investments each year. Mike starts saving $ 200 per month in his company’s 401k plans at age 25, with an additional $ 100 per month contributed by his employer, for a total of $ 3, 600 per year. In the course of a 40-year career, contribute $ 96,000 to your retirement plan. At age 65, Mike’s balance grows to $ 468, 636.
Tom, on the other hand, waits until he’s 45 to start saving on his employer’s plan. Contribute $ 400 per month, with a sum of $ 200 from your employer, for a total contribution of $ 7,200 per year. While Tom contributes the same total amount as Mike, $ 96,000, his investment only takes 20 years to grow. When he retires at age 65, his total investment is only $ 250, 923, an amount approximately half of Mike’s final balance.
Your final balance is the total amount of money you invest, your rate of profit and the time your investment can grow. Saving more and more time reduces the amount of profit you must achieve to reach your ultimate goal. As the rate of profit decreases, the amount of risk needed to capture that income rate also decreases, expanding the investment options available to you.
2. Your retirement time frame
The time between today and the day you want to retire is an important consideration when selecting the best investment plan. In a nutshell, you can afford to take more risks when you have more time. Most of the investments are volatile in the short term: initially their prices rise and fall depending on the psychology of the investors, instead of the real financial results. As time goes by, real results replace psychology, so prices reflect the company’s ability to generate profits consistently. The potential becomes reality.
As an example, the price of Apple shares closed on February 15, 2013 at $ 442.80 per share; one year later (February 14, 2014), it closed at $ 543.99 per share. If you had purchased the shares on February 15, 2013 and sold them on February 14, 2014, you would have earned $ 101.19 per share or 22.8% of your investment. During the year, however, the price of the shares varied from $ 385.10 per share (April 19, 2013) to $ 575.14 (December 5, 2013). In other words, he could have lost as much as 13%, or have gained as much as 29.8%, if he had sold his shares before the end of the year.
By looking at long-term trends, Apple is an excellent example of continuous growth. Apple has shown the quality of its management for years, and the first investors are now reaping the rewards. For example, Apple shares in 2009 reached $ 213.95, and Apple shares in 2004 reached $ 34.40. A person who bought Apple shares in 2004 for approximately $ 34 per share and sold on February 14, 2014 for $ 544 per share, would get a return of 1,600% on his initial investment. This shows the benefit of time when considering risk and reward.
Unfortunately, as the retirement age approaches and the investment horizon is shortened, the security is lost that the good administration of the company results in an increase in the price of the shares. Even if you need to reduce your investment objective, it is advisable to choose safer investments, reducing volatility by exchanging potential for certainty. While a 30-year-old man can invest aggressively, taking 35 years or more to make up for the mistakes, a 60-year-old man does not have that luxury since time is not on his side.