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Building a Nest Egg

Getting to know your 401(k) plan

By Michelle Suthard

Many of you will soon be starting your first professional career position. Congratulations! Now that you’ll be getting a regular paycheck, it’s time to start thinking about adult things like paying taxes and even retirement. It might seem way too soon to plan for your golden years, but every little bit you save now, will secure a more comfortable retirement for your future.

Most employers offer a 401(k) plan to help with your retirement goals. Your contributions are deducted tax-free from each paycheck. Some employers will even contribute funds on your behalf. Don’t wait to get started with these benefits. If your employer offers a 401(k) plan, take advantage of it right away and begin building up your retirement nest egg.

Keep in mind, however, just because your employer offers a 401(k) plan doesn’t mean that they will make all your investment decisions. You get to be in charge of how much money is contributed, where the money is invested and for how long. This may seem daunting and complicated, but don’t worry, you’ll find it really isn’t too difficult!

Consider Your Style

The first question to consider is your investment style. There are three main investing profiles: conservative, moderate and aggressive. Think about your time horizon, which is the number of years you have before you retire. You’re probably many years away from retirement, so you should be investing in more risky investments that have the potential for significant appreciation. This is because you have more time to weather the expected ups and downs of the market.

Next, think about your risk tolerance. This simply means how you feel about risk. Some investments are more risky than others. It’s important that you select investments that won’t keep you up worrying at night. If you don’t know right away which one of the three main investor types you are, ask your plan administrator for an Investor Profile Questionnaire. You’ll answer some questions that will identify which group you fall into. This will help you determine your investment objectives. Once you know and understand your risk tolerance, it’s time to pick investments based on this investment strategy.

Your 401(k) plan probably offers many different investments in various categories. These investments generally fall into four groups: equities (also called “stocks”); bonds and other fixed income investments; stable value investments; and short-term investments, like money markets. Knowing your investment strategy and risk tolerance makes picking the right investments that much easier. Following is a brief description of each of the four investment groups.

The Four Investment Groups

Equities are generally investments that give you an ownership interest in the company issuing the stock. If the company does well and its stock price increases, your investment will gain in value. Among plan investments, stocks offer the highest potential investment returns, but also involve the most amount of risk to the amount you’ve invested.

Fixed income investments, such as bonds are in effect, loans owed to the investor by the government, corporations or other issuers of debt. Typically, bonds pay a fixed rate of income over a set time period. These investments usually rise and fall in value depending on current interest rates. The general rule: if rates rise, bond prices fall and if rates fall, bond prices rise. Bonds are generally seen as involving less risk of loss than stocks, but also offer lower potential returns.

Stable value investments include Guaranteed Investment Contracts (GICs) offered by corporations, insurers, banks and other lending institutions. This category offers low risk and returns that historically have been at, or slightly above, inflation.

Money market investments pay an income for a short period of time. These investments may pay a fixed or variable interest rate during the period. Money markets offer the least risk of loss but pay potential returns that are lower than returns on both stocks and bonds.

Diversification and Allocation

Diversification is not as complicated as it sounds. It simply means spreading your money among different investments. Diversification attempts to take advantage of the pluses of each investment, with the goal of earning more consistent investment returns. Based on your individual investment strategy, you can diversify your plan investments by investing in different types of funds. For example, by spreading money among the plan’s investment alternatives—such as a stock fund, a bond fund and a money market fund—you would diversify your plan investments more than by investing in just one type of fund. Remember, diversification can only help control risk—it does not insure against possible market losses.

Lastly, you need to determine your asset allocation or how much money you want to put into the various types of funds.

As an example, let’s say you’re a moderate investor in your early 30s—typically you’d be advised to allocate the largest percentage to equities, about 15-25% to fixed income and the remaining percentage to stable value and/or money market funds. The decisions of which funds to choose and how much to put into each depends largely on your personal situation: the time you have until retirement and the amount of risk you’re willing to take.

Keep on Track

Don’t forget to review your investment mix—that means actually reading your 401(k) statements! Your statements (usually sent quarterly) will show your contributions, your asset allocation, and how much you own of each fund at the period end. It may even show your personal rate of return for the period. Assess your investments to ensure that they continue to reflect your investment goals. You should do this at least annually, if not more often. For example, you may want to rebalance your investment mix if one type of investment or another has done especially well—or poorly. You may have to reallocate your money among your fund investments to return your portfolio to your desired mix.

Since the likelihood of social security being around when you retire is slim, don’t waste another minute—start implementing your 401(k) strategies today! If you have additional questions, speak with one of your plan representatives or a financial advisor.

Michelle Suthard is a certified public accountant working for an asset management firm in Chicago.


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