The sands of time flow swiftly through the hourglass, and no matter how young you are or feel, before you know it, retirement will be upon you. Will you be ready? I know it can be tempting to put off planning for your golden years, but the choices you make today will have a dramatic effect on the quality of life you can live in retirement.
Hands down, the easiest and most effective thing you can do to build a comfortable retirement is to maximize the benefits of your 401K. Most companies offer some degree of company match for 401k contributions. For many companies that amount is set at $.50 per dollar for the first 4% of salary contributed. Folks, this is free money! By taking advantage of it you are giving yourself an immediate 2% raise. I don't know about you, but in my opinion, turning up your nose at free cash is insane. So step one is: make sure you are enrolled in your company's 401k, and you are contributing the maximum allowable for the matching funds.
The next important step is: diversify your 401k investments. Diversification protects you from large losses, and allows you to benefit from the ups and downs of different sectors and investment types. Failing to diversify was the major mistake made by employees at Enron, Worldcom, Tyco and other victims of the corporate corruption of the early part of this century. The employees at these companies often put the majority of their money into their company stock. This was not a safe plan. When their companies collapsed, they lost their jobs, and they lost their retirements almost overnight. If they had spread out their retirement funds, they would have at least been left with a good portion of their retirement savings to lean on.
So how should you diversify your 401k retirement funds to protect yourself? Well, first things first, avoid the mistakes made by the unfortunate folks we just discussed. In my opinion, put no more than 25% of your 401k funds into the stock of the company you work for. That is the most. I actually recommend putting in less, around 15%. Second, go for fixed income. Fixed income funds, which often have names like "Total Return" are a safer, steadier investment, that will grow over time. They also provide regular income to your account that can then be reinvested in other investment types. They will avoid the highs and lows often seen by stock investments, and protect your retirement from being subject to a sudden market drop near the beginning of your retirement. I currently recommend putting around 40% of your retirement funds in secure fixed income instruments.
After building a solid foundation of fixed income, and limited company stock, you want to continue the diversification of your investments. The next key building block would be a S&P Index Fund. Pretty much every company's 401k will have this as an option. For those who are unaware, this type of index fund tracks the movements of the S & P Index (which is made up of the 500 largest companies in the US). By owning this type of index you have instant diversification and exposure to the largest and most profitable companies in the country. If the economy as a whole is doing well, your index will also likely do well. If one sector of the overall economy is struggling, you will not suffer because you are diversified. I recommend investing between 25% and 35% in this type of fund.
Finally spread the remainder of your funds between the other available investment types, always choosing the option with the best five and 10 year returns. I would recommend investing some money in a mid-cap fund (a mutual fund specializing in investing in mid-sized companies), an international fund (to benefit from fast growing emerging markets) and maybe a managed fund or two. A new option is "target date" funds that do most of the diversification for you, and adjust the risk profile as you move closer to retirement. All of these options will fill out your portfolio diversification and help build towards a safer retirement.
Remember, the most important safeguard is research. Look at your options. Find the investments that are the most consistent, and continue to research them as you own them. Also, know your risk tolerance. If you are more risk-averse, then put more of your money in safer vehicles like fixed income. I don't recommend going for a more aggressive portfolio in your 401k. This is your safety net. If you want to swing for the fences, do that in a trading account that you are not relying on for your retirement. Make your 401k the base of a strong retirement plan that will also feature a Roth IRA, bonds and other assets. But get started now.
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