Tips on Making the Most of Your First 401(k)

Whether you've invested before or not, enrolling in a 401(k) plan for the first time can be both exciting and nerve-wracking. Sure, saving for retirement may make you feel good about taking responsibility for your future, but how do you decide what to invest in or how much to save, and how do you make sense of all those plan rules? These and other questions often vex first-time 401(k) users, and the fact that 401(k) plans vary in quality and structure doesn't help.

While many employers do a good job of educating their employees about how to use their plans, others do not--or perhaps employees simply aren't listening. About 52 million Americans participated in 401(k) plans in 2012, yet many still are not saving enough for retirement or have developed bad habits, such as taking out loans that inhibit the growth of their accounts.

To help guide those who are new to 401(k)s and other employer-sponsored retirement plans, we asked Morningstar.com readers on our 401(k) & IRA Planning discussion board for advice. Readers provided tips on everything from saving enough to picking the right investments to simply taking the long view about the whole process. You can read the full conversation here. Excerpts are below.

'Maximize Your Contributions'
Some comments focused on the question of how much to contribute to an employer's retirement plan, with many urging first-timers to save as much as possible.

Garrettvandrews wrote, "Maximize contributions. Assuming the investor is young, invest aggressively, diversify, and consider [choosing a Roth account]. Plan on not withdrawing for 40 years."

"What one piece of advice? I'd say maximize your contributions: a minimum of 18% over a career (or even better, 21%), aggressively invested in an allocation of mostly equities (about 70% domestic, 30% international), ultimately results in a sizable nest-egg for retirement," said Gatorbyter. "Much more than being investment-savvy, being a healthy saver is the biggest factor towards financial security. And paying yourself first is an excellent way to promote responsible spending habits. In time, you forget that you are putting that money away. It simply becomes second nature and you won't miss what you never had (so to speak)."

A few readers mentioned saving for emergencies first, then focusing on retirement.

Yogiman wrote, "First, build an emergency fund. Second, contribute to the 401(k) 10-15% of your pay or at least up to the company match, mostly in stock funds until you get older. Third, don't fiddle with it when the market goes down--only look at it every six months. Fourth, remember, a 401(k) is like a bar of soap--the more you touch it, the smaller it gets."

Readers also urged 401(k) first-timers to contribute at least enough to qualify for their employers' matching contributions.

"Start out by contributing enough to maximize the company match," recommended offthegrid2. "Increase your contribution rate whenever you get a raise to a dollar amount equal to at least half your raise, preferably all, until you reach the max 401(k) limit. You can do the Roth step [diverting funds to a Roth IRA] after the match if you wish, but do it with automatic payroll deduction to keep the money out of your hands. This will be an automatic way to keep your spending from growing too quickly while at the same time growing your savings rapidly."

Of course, if you can't max out your 401(k) account, saving something beats saving nothing, said dnwrkn.

"My advice to first-timers is don't worry about how little you have available to save, just start," the commenter wrote. "It's very simple to say to contribute up to the max, but that is probably out of reach for most first-time 401(k) investors. The salary on my first job out of school was so small I could barely afford food and rent, let alone think about retirement. So I started with just 1%. The HR manager said I was crazy to leave money on the table from missing out on the matching. When I got my first raise, I put in another 2% to get the full matching. The next year I got a bigger raise and doubled up to 6%. Once the habit was there it was easy to keep up the pattern. Each year I added more until both my wife and I maxed our contributions, which we have been doing ever since."

'Invest Aggressively'
Another major topic of conversation was how to allocate one's 401(k) assets. Based on the assumption that most 401(k) newbies are younger investors who won't need the money for three decades or more, many readers urged them to use allocations heavily weighted toward stocks.

"If you're reasonably young, then invest aggressively," said dakahuna1. "You have a very long time horizon. Investing too conservatively will only hamper your retirement goals. Don't worry about the ebbs and flows of the market. It's immaterial for decades."

But other posters suggested that 401(k) newbies invest in balanced or target-date funds that hold ample weightings of both stocks and bonds.

Mysticaltyger wrote, "Most of us (myself included) are really bad at guessing our risk tolerance in advance. But it turns out most people can handle balanced and target-date funds ... so those are excellent funds to start with, and if they're the only retirement type investment you have your whole lifetime you will probably be fine."

Bgstuhan agreed, saying, "Assuming that this person has few or no other assets, my advice would be to contribute 100% to a target-date fund. ... While it's worthwhile to learn how to manage your investments yourself, paying a few hundred dollars in fees to have someone make an allocation that's likely to be as good or better than any that you can come up with is reasonable."

'Do Your Research'
Among the biggest challenges 401(k) investors face is understanding whether they're getting a good deal from their plans. Recent changes have made information on plan fees and expenses more transparent but still fall short of spelling out exactly how much each participant is paying to invest.

"1. Check the annual fees/share classes on your available funds and pick the most cost-effective ones for your investment needs," suggested rforno. "2. Do your research on target-date fund composition and fees; don't just assume they're ideal for you because they're available for you. 3. Remember that funds in a 401(k)/403(b)/457 are selected by an 'advisory' committee by your employer. Meaning there likely will be no rhyme or reason why fund X was selected over fund Y other than perhaps a fee incentive one way or the other, and that incentive may or may not benefit you."

"Not all 401(k)s--or their 403(b) or 457 equivalents--are created equal," wrote rfalcon. "Investigate the plan thoroughly, especially costs, before signing up. Employer matching makes up for a great deal, but employer matching appears to be getting less prevalent, and less generous. Every plan and each individual is different, and the 401(k) your company offers may only be worthwhile up to the limit they'll match funds but too expensive beyond that point. And if your company doesn't match funds, there may be less expensive options available elsewhere. Do your homework before you get involved."

'Remember That This Is a Long-Term Endeavor'
Beyond advice on managing investments and watching fees, some readers offered 401(k) first-timers pearls of wisdom about how to manage themselves and their behavior when it comes to saving for retirement.

"Ignore the value of your holdings, particularly during periods of horror and exuberance," said kdh1979.

"Remember that this is a long-term endeavor and the market will go down, but historically over time will be up," offered FingerlakesGuy. "Invest as much as you can, allocating appropriately for your age and what you can sleep with at night, stay the course in good and bad markets, and keep a cash cushion to get you through the bad times and bad markets and not have to sell your nest egg."

Turning to others for guidance also helps, said jr99.

"Find a friend or relative to mentor you on investing," the commenter wrote. "This should be someone who has been investing themselves for many years. You don't want someone to tell you what to invest in. You want someone to answer your questions and guide you. Someone like this can really help when markets go down. Some of my best mentors were bosses I worked for." 

Finally, keep in mind that saving for retirement takes time and requires patience, said Xatlantica.

"Don't be dismayed/disheartened by the seemingly small size of your nest egg when you first start out," the commenter wrote. "It may seem that you are trying to build a mountain from grains of sand. But in a few years you'll be surprised at how the money accumulates. Remember, you are investing, not stuffing cash in a mattress. It's not just the money you (and hopefully your employer) put in, it's the return you get for letting your money 'work.'"