What You Need To Know About Your 401(k) Podcast


In this episode of The Science of Economic Freedom, “What You Need to Know About Your 401(k),” you’ll discover what we consider to be the five best practices when managing your 401(k)-type accounts. Subjects in this podcast include:

• Why you need to participate, save and maximize your retirement accounts.
• Limits and catch-up provisions.
• Taking advantage of your company’s employee “match.”
• How to assess and self-select your investment risk tolerance.
• Key concepts to understand when conducting a quarterly review of your accounts.
• Why it’s essential that you “take your 401(k) with you,” i.e. rollovers, etc.
• Investment choices and “target maturity funds.”
• Other must-know concepts, lingo and frequently asked 401(k) questions.

 

Transcript:

Doug:               Why you must get started with your 401(k). How do you make investment choices in this account? Should you roll over your 401(k) when you leave a job? What you need to know about 401(k)s on this episode of The Science of Economic Freedom.

 

Announcer:       The Science of Economic Freedom is intended as an investor education resource. The views and opinions expressed on this program should not be construed as a recommendation to buy, sell, or hold any specific security. Consult your investment advisor and read any investment prospectus carefully before making any changes to your investment portfolio.

 

This program is sponsored by Mercer Advisors. Mercer Global Advisors, Inc. is registered with the Securities and Exchange Commission and delivers all investment-related services. Mercer Advisors, Inc. is the parent company of Mercer Global Advisors, Inc., and is not involved with investment services.

 

Doug:               Welcome to The Science of Economic Freedom. I’m your host, Doug Fabian. This podcast is all about helping you achieve your financial dreams. We call that economic freedom. This program is about your journey to achieve economic freedom for yourself and your loved ones. Today, we want to help you identify your next step on that journey.

 

This is Episode 16: What You Need to Know About Your 401(k). Now, let’s remind ourselves about the definition of economic freedom. You go to work if you want to. It means that you’ve accumulated enough assets that you can live off the income stream from those assets.

 

How do we achieve economic freedom? By accumulating assets that will produce an income stream at a later date. Your 401(k) plan or similar retirement savings accounts will be one of the key assets to drive your economic freedom if you manage it properly.

 

Your takeaway from today’s episode will be the five best practices when managing this retirement account. We want to help you make sense of your investment choices, and we’re going to talk about some special features of 401(k) plans that you may not be aware of.

 

When we talk about a 401(k), we’re also talking about similar retirement accounts: a 403(b), a 457. If you work for the federal government, you might have the Thrift Savings Plan, or TSP. All of these retirement accounts are similar. They’re called defined-contribution retirement accounts, and this means that the employee is responsible for contributing and making decisions on this retirement savings account.

 

With that in mind, here are our best practices when managing your 401(k).

 

Best practice number one, participate, save, and maximize. Here’s what we mean by “participate”. This means that you’re going to enroll in the 401(k) program. Statistically, about 80% of people who have access to a 401(k) plan do participate. 20% don’t participate. But no matter where you are on the road to economic freedom, participating in this plan is critical.

 

Second, the most important component here is savings. So you’ve got to save some money, and you can determine how much money you’re going to save. There is an advantage to saving money in a 401(k). That money comes off the top of your paycheck. You’re not going to pay any taxes on the dollars that are going into a 401(k) plan.

 

And remember this: In the first 10 years, the most important component is not what you’re invested in, it is the fact that you are saving money, you’re creating that nest egg, you’re creating that fuel for future growth by saving money.

 

And then, let’s talk about maximizing. In an ideal world, if you could maximize your 401(k) contribution every year, you’re going to get to economic freedom sooner. Now, a maximum contribution to a 401(k) plan in 2018 is 18,500. If you’re over age 50, there’s a catch-up provision of an additional $6,000 a year, so the maximum contribution is 24,500.

 

We realize that everyone might not be able to maximize their 401(k) plan right now, but you should be thinking in terms of savings goals. I’m going to contribute $5,000 this year to my 401(k), or $10,000 this year to my 401(k). And, since this is a marathon and not a print, every time you get a raise, you want to increase your contribution to your 401(k).

 

In an ideal world, maximizing your 401(k) contribution would be a sign of very good financial health, and you’re moving down the path to economic freedom must faster.

 

Moving on to best practice number two, get the match. Many companies offer a percentage match of an employee’s salary to your contribution. For example, a typical match is 3%. This means that if you contribute 3% of your salary, the company will also contribute another 3% for a total of 6%. This match is free money, so you can continue to maximize your 401(k) contribution and get the company match, and therefore save even more.

 

Now, not all companies offer employee matching, so you need to check with your HR department, understand if your employer is making some sort of match to your 401(k) contribution. But best practice number two is, get the match.

 

Best practice number three, self-select your risk tolerance. Now, what is risk tolerance, and what is risk tolerance to you? Risk tolerance is all about understanding yourself and how much volatility you can take in your investment portfolio. You can type into your search engine, “What is my risk tolerance?” and you will get many websites that’ll take you on a short questionnaire, 6-10 multiple-choice questions, that will help you determine your risk tolerance.

 

What we’re trying to do here is determine how much stock market exposure we are going to have, because if we have too much stock market exposure and you see that your 401(k) plan has too much volatility and it’s going down too much in a down market, you’re liable to want to jump in and make some changes.

 

Now, I did this today for myself, and I’m a moderately aggressive investor. This means that I would have a 70/30 or an 80/20. The 70 or the 80 is the equity allocation. That’s for me. Once you know your risk tolerance, you’re in a better position to select your asset allocation.

 

We’re going to talk more about stocks, bonds, and cash in a moment, but I do want to point you back to Episode number 8. The most important decision we make in our investment strategy is our asset allocation, and this also ties into investor behavior, because investor behavior is a mechanism or a description on how people will go in and make changes to their investment portfolio based on what’s happening in the news, and throw off their long-term investing results and strategy.

 

Getting your risk tolerance right is the first step towards avoiding bad investor behavior.

 

Best practice number four, review your 401(k) plan, your investment strategy, and your investment results on a quarterly basis. Now, here’s what you should look for. First, did all of your savings from your paycheck go into your 401(k) plan? You want to compare your 401(k) statement with your pay stub.

 

Second, how were your new contributions invested in your 401(k) plan during the past quarter? Were they invested correctly?

 

Number three, look at the change in value in your 401(k) plan for the previous quarter, and this is the time when you want to review your asset allocation. One of the things that does not happen in 401(k) plans is rebalancing. You as the investment manager of your 401(k) need to do the rebalancing.

 

I’m going to talk more about specific investment strategies where there is some automatic rebalancing in a moment, but if you have selected a 70% stock market allocation and a 30% fixed-income allocation in your 401(k) plan, and we’ve gone through a very strong year in the stock market, you now might have an 80% equity allocation because the stocks went up so much.

 

You might want to sell down 5% or 10% of your equity allocation—this is called rebalancing—in order to be able to stay on track with your asset allocation and your risk tolerance. You want to review your asset allocation on a quarterly basis and make sure it’s aligned with your risk tolerance.

 

Next question, do you have any international exposure? Many times, people own just US stocks, and we firmly believe that owning a combination of US stocks and international stocks is important.

 

And then, lastly, glance over the investment choices that you have available to you in your 401(k) plan, and just do some comparative analysis of where you’re at. Rarely make changes to your 401(k) on a quarterly basis.

 

And then, lastly, we want to encourage you to review your 401(k) plan with your spouse.

 

Next best practice, number five, take it all with you. There are always exceptions to these kinds of recommendations, but in most circumstances, when you leave your job to go to a new job, you should take your 401(k) plan with you.

 

When you do that, you have two choices. You can move, transfer, your 401(k) plan from your old company to your new company, or you can take your old 401(k) assets and put them into an IRA. It’s called a rollover. So let’s talk about the difference between those two.

 

First of all, looking at your new 401(k) plan, maybe it has better features and better investments than your old 401(k) plan, so it might be a good choice to move from one 401(k) to another. But, if you want to get access to more investment choices and be more in control of your retirement accounts, taking your old 401(k) and putting it into an IRA can be a good choice, and then you would also have access to professional management if you so desire.

 

One final thought on leaving your 401(k) at your old employer. You will be paying higher fees if you do so, because your old employer is no longer obligated to pay your 401(k) fees because you no longer work at the company.

 

Those are our five best practices for managing your 401(k). I’d like to move on to talking about investment choices and give you an overview here. We’ve talked a lot about stocks, bonds, and cash, but when you have a 401(k) plan, you have a limited number of choices. One of the categories of choices that’s very popular these days is called target maturity funds.

 

These are mutual funds that have an asset allocation within them that is based on a target retirement date. That target retirement date could be 10 years, 20 years, 30 years in the future. What these funds are doing is they’re adjusting the asset allocation based on your age. The longer dated funds are going to have a higher allocation to the stock market than the shorter dated funds.

 

One of the advantages of these target date funds is the fact that they do rebalancing for you, and they’re going to adjust the asset allocation over time based on this target retirement date.

 

You also want to look at your 401(k) plan relative to your international choices, and you have to dig a little deeper into those target funds to see if they have any international exposure, but we do advise having some international exposure in the mix of your asset class of stock or equity investments.

 

Here’s a tip on fixed income securities. You may have two, three, four, five choices in the fixed income category, and when you look at those choices and their performance, one of the categories that they’re going to give you is the category of yield, and some fixed income choices yield more than others.

 

But a good rule of thumb to understand is, the higher the yield, the higher the risk. So you have to realize that, if you do choose a fixed income fund that has the highest yield, you are going to have a higher degree of risk in that fund.

 

Lastly, let me mention company stock. If you work for a publicly-traded company, you may have access to that company’s stock within your 401(k) plan. You have to realize that this is a single company and your asset allocation to that single company is going to be volatile because there’s very little diversification in a single company. You don’t want to take too much individual stock risk by investing large portions of your 401(k) plan in company stock.

 

Now, let me also talk about some features of 401(k) plans, and, again, each 401(k) plan is different and you don’t know what features your plan is offering until you dig into the detail. But many 401(k) plans do offer a loan provision where you can borrow from your 401(k) plan.

 

This is not a good idea. Borrowing from your retirement account doesn’t make a lot of sense, because you’re going to be pulling the money out, and that money is no longer going to be invested, and you do have to pay interest on money borrowed from a 401(k) plan.

 

Another feature is matching. We talked about matching today. Every plan is different, so you need to investigate what the matching provisions are within your 401(k).

 

Your investment choices in every 401(k) plan are different, but a new feature that has come along recently that we should talk about is the Roth 401(k) option.

 

A Roth 401(k) option is a very good option because, when you have assets invested in Roth status, you have tax-free accumulation and, at retirement, you have tax-free withdrawal. A regular 401(k) plan, when you go to withdraw the money, you’re going to have to pay taxes on those assets when you pull them out based on your current tax bracket.

 

But a disadvantage of the Roth 401(k) is you do not have the tax deductibility, or you are not going to receive the advantage of not paying taxes on the 401(k) contribution into the Roth. So there are some important things to understand about the Roth 401(k) provision.

 

Let’s talk about some action steps. We never want to leave a subject without talking about next steps. What should I do this week regarding my 401(k)? So here is a summary of what you should do from this discussion on 401(k)s.

 

Number one, print out your current 401(k) statement and check off best practices number four. Remember best practices number four is making sure all your savings are going in correctly, looking at your asset allocation, looking at the performance of your 401(k) for the previous quarter, checking on international exposure, and discussing it with your spouse.

 

Number two, review the features of your 401(k) plan. All 401(k) plans are different. Contact your human resources department with any questions that you might have about your 401(k).

 

Number three, the risk tolerance questionnaire. Put into your search engine, “What is my risk tolerance?” Know what your risk tolerance is, because this is important when you look at your asset allocation.

 

Number four, what is my 401(k) savings target this year? Is it $3,000, $5,000, $10,000, or can you reach the max, which this year is 18,500?

 

And then, lastly, talk with your spouse about your 401(k) status today.

 

Now, this was a deep discussion about 401(k)s. You may need to listen to this episode again. There’s lots of action items. But your 401(k) plan will be a key component of achieving economic freedom if you manage it right.

 

Now, if you’d like to ask me a question, you can send me an email. My email address is [email protected], [email protected]. I’m interested in your questions, your comments, ideas for show topics, and, if you would like to set up a wealth coaching session with me, you can go to the scienceofeconomicfreedom.com or send me an email to [email protected] and we’ll get that wealth coaching session schedule.

 

This is Doug Fabian. Thanks so much for listening.

 

Announcer:       The Science of Economic Freedom is intended as an investor education resource. The views and opinions expressed on this program should not be construed as a recommendation to buy, sell, or hold any specific security. Consult your investment advisor and read any investment prospectus carefully before making any changes to your investment portfolio.

 

This program is sponsored by Mercer Advisors. Mercer Global Advisors, Inc. is registered with the Securities and Exchange Commission and delivers all investment-related services. Mercer Advisors, Inc. is the parent company of Mercer Global Advisors, Inc., and is not involved with investment services.

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