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By Christine Benz and Adam Zoll | 04-07-2014 05:00 PM

How to Make the Most of Your 401(k)

In this special presentation, get the answers to key questions about the quality of your plan, whether your savings are on track with your goals, how to allocate assets, and what to do with assets when you leave your job.

Adam Zoll: Thanks to everybody for coming out tonight to talk about the topic of 401(k) retirement plans. As you know, the name of tonight's presentation is how to make the most of your 401(k), 403(b) or 457. We generally use the term 401(k), but the other retirement plan types, 403(b) and 457, are very similar. When you hear us talk about a 401(k), but you have a 403(b) or 457, generally what we're saying will apply to you also.

Tonight's presentation is structured around four key questions to ask in order to help you get the most out of your 401(k). But before we do that, let's review some of the advantages of a 401(k) plan to remind ourselves of why we're here talking about this topic.

A 401(k) has the advantage of giving you a direct payroll deduction in order to fund your retirement, which is an easy and convenient way to save. The money never makes it in your pocket, therefore, you're never tempted to spend the money, and that will apply some good sort of behavioral discipline as you go along and save over the years.

Your employer may provide matching funds that help your retirement savings grow faster. We'll talk a little bit more about matching funds a little bit, but this is essentially your employers giving you free money to save for your own retirement, which is pretty darn good deal.

Number three, earnings in the account grow tax-free or tax-deferred, which is also an advantage. You do not have to pay taxes on the money as you go year after year. Again, this allows your account to grow faster. And you get a tax break when you contribute to the plan if you're using a Traditional plan type, or when you take the money out if you're using a Roth plan type once you reach at least age 59 1/2. These are more tax advantages tied to the 401(k) structure that you can take advantage of by saving over long periods of time.

As I mentioned we've structured tonight's presentation on these four key questions. I'm going to take the first two and then [Morningstar director of personal finance] Christine Benz is going to come up here and take the second two. The questions are:

  • How good is my plan?
  • Are my savings on track?
  • How should I allocate my 401(k), 403(b), or 457 assets?
  • What do I do with assets once I leave my job?

Our first question is: How good is my plan? It is a pretty important question. Some of the things to consider are the fund lineup available to you. The fund expenses, plan expenses, the company match, the Roth 401(k) option, and the availability of additional help. We're going to take these one by one to discuss what you need to be watching for.

At a minimum, your employers' plan should include the following basic fund types: a U.S. large-cap stock fund, a U.S. small-cap stock fund, a foreign-stock fund, and a bond fund. So these are the basic building blocks of a diversified retirement portfolio. Remember that you're saving, in many cases, over decades, and you want to have that well-diversified portfolio that is going to be able to cushion you if things go wrong in a certain segment of the market. If things go wrong with foreign stocks, for example, you don't want all your eggs in that one basket. You certainly don't want all of your retirement savings or too much of your retirement savings in your company stock, which a lot of people have found out the hard way is not a good investment strategy. You really want to be able to spread yourself broadly so that you're covering lots of different pieces of the market. Christine is going to be up here a bit later to talk about asset allocation, and she will talk about that in greater depth.

Index funds are a component of many 401(k) retirement plans. One of the big advantages of index funds is they're generally a lot cheaper than actively managed funds. Just briefly, if you're unsure what we mean when we say index versus actively managed, an index fund is a fund that essentially tracks an index of stocks or bonds of specific types. So, you may invest in a large-cap stock index or an index of U.S. investment-grade bonds, whereas an actively managed fund has a manager who is actively picking and choosing specific securities to invest in that he or she thinks are a good investment. That sort of active management approach is generally more expensive; tracking an index is a lot less expensive. And keeping your investment costs low is a pretty key component to having a successful retirement savings experience.

Many 401(k) plans have very few index options, unfortunately. Some things to watch for as you sort of do your due diligence on your own plan: Are index funds available, how many of them are there, and if you're interested in using index funds, how can you build your portfolio? Are the plan's offerings going to meet your needs?

Another very popular component of 401(k) plans is the target-date fund, which some of you may be familiar with. This is basically an all-in-one diversified portfolio that you can get by owning just one fund. I kind of think of a target-date fund as two different valuable pieces. One is this diversified portfolio, the other piece is that the allocation between stocks and bonds and cash changes over time so that the closer you get to your retirement date, that is automatically rebalanced for you. It's really kind of one-stop shopping for many investors who don't want to be bothered with rebalancing on their own, rebalancing their portfolios themselves, and maybe aren't sure exactly what investments are good for them. A good target-date fund can take care of that for you, and in fact, these days many employers are auto-enrolling, automatically enrolling their employees, in target-date funds that are age-appropriate for the employees. So they're really growing in popularity.

Fund expenses. Here what we're talking about are the expenses charged by the fund itself in order to do the investing on your behalf. So these are the expenses charged by the mutual fund as opposed to the expenses charged by the 401(k) plan, which we will get to in a moment. So fund expenses will appear on your plan documentation that you receive probably about once a year that sort of describes the layout of your plan. And these expenses are expressed as a percentage of assets and also as a dollar amount per $1,000 invested. So, if you're invested in a fund that charges 1% of assets as its expense ratio, then you're paying $10 per $1,000 invested. As a very general rule of thumb, an actively managed fund should charge no more than about 1% and an index fund no more than about 0.25%.

And I should also mention, I forgot to say at the top, we're hoping to have time to answer your questions at the very end. So, if you do have questions that come up as you go along here, please save them for the end and then we will address those.

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