Are you getting the most from your 401(k)? Many people aren't.
To obtain the maximum benefits from your 401(k) plan, you have to make two key moves. First, you need to contribute as much as you can afford. And second, you need to invest for long-term growth.
Let's look at the issue of contributions first. There are very few hard-and-fast rules in the investment world—but it almost always makes sense to contribute as much as you can afford to your 401(k). After all, you generally invest in your 401(k) with pretax dollars, so the more you put in, the lower your annual tax bill. Furthermore, your earnings grow on a tax-deferred basis, which means you'll have more of your money working for you right away.
If you're lucky, your employer will match part—or even all—of your 401(k) contributions, up to a certain level. So, if you're not contributing enough to your 401 (k) to qualify for the full matching amount, you are literally "walking away" from money that's being offered to you. And that's never a good move.
Now, let's look at the other important move you could make to reap the greatest benefit from your 401(k): investing for long-term growth.
Many people mistakenly treat their 401(k) plans as short-term investment vehicles, and they become overly concerned with the market's daily and monthly price swings. As a result, when deciding which 401(k) options to invest in, they pour too many dollars into very conservative choices, such as money market accounts.
If you start contributing to your 401(k) when you're in your 20s or 30s, you've got several decades of investing ahead of you. Because of this, you may want to consider putting the bulk of your 401 (k) money into growth accounts, which are made up largely of stocks.
At first glance, that may sound like a risky strategy, given that stocks are more volatile than other types of investments. However, these price fluctuations tend to smooth out over time—so the longer you hold stocks in your 401(k), the less likely you are to lose money. Conversely, stocks have historically appreciated much more than any other type of asset class, such as bonds, money market accounts and government securities.
Of course, to maintain this strategy, you may have to overlook the short-term price swings that will come your way. Some months, you may not want to even look at your 401 (k) statement— so don't. Remember, you're not investing for next week, next month or next year—you're investing for decades down the line.
As you get closer to retirement, you may want to gradually move some of your 401(k) money into more conservative vehicles—but don't do it too soon. If you give your investments the time they need to grow, your patience may ultimately be rewarded.