401ks are investment plans that are provided by your employer. When you have been determined eligible to contribute to a 401k (there may be a waiting period at your company) you can then set up an allotment of funds to be deducted from your paycheck every month.
This amount is generally a percentage of your income, and employers may offer matching funds up to a specified percentage. The employee match, and tax benefits are the two best reasons to take advantage of your company’s 401k.
Where Should I Invest My 401k To Maximize Returns?
While the goal of any investment strategy is to ultimately make money, how you arrive at that point depends largely on how much risk you can handle.
Conventional wisdom dictates that the younger you are, the more risk you can handle. That risk is essentially scaled back as you age, and become closer to retiring and needing the money.
If you are in your twenties as much as 100% of your portfolio can be in high-risk funds, as their day-today volatility will be minor compared to long term gains. The closer you are to retirement, the more scaled back your portfolio should get, with more capital moved to bonds and other stable investments.
Contributions to your 401k are made with pretax dollars, and this fact can lower the amount of income tax you pay. The funds are taxable when you withdraw them upon retirement. A Roth 401k is also an excellent option, as you are taxed on these contributions when you make them, not when they are withdrawn.
Research Is important With 401ks
A 401k needs to be monitored and tracked at all time to make sure you are not over-exposed to an industry sector or singular company. It is strongly suggested that you do not invest in your company’s stock, and if you do, limit it to a small percentage of your portfolio.
While it is never wise to have all of your eggs in one basket, investing too heavily in your company’s stock exposes you to twice the risk as simply overweighting a company or sector. You are already tied to the fate of your company simply by being an employee. If something were to go wrong, you would be out of a job and take a hit in your portfolio.
There are a handful of exceptions to this rule, but unless you are a highly paid executive, they probably do not apply to you. It is much better to invest outside of your company, in diversified funds. Review your annual report, which is provided by your company at least once a year. Check carefully for accuracy, and make sure your contributions are being recorded correctly.
Early Withdrawal Penalties
Money in a 401k earns interest while it is in the account, and once you retire it can be withdrawn without penalty. The retirement age for a 401k is 59½ years. If you withdraw money from your 401k before this time then you will be subject to a penalty fee, and you will have to pay income tax on the amount of the withdrawal.