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12 Steps to a Stronger 401(k)

12 Steps to a Stronger 401(k)

Set yourself up for 401(k) success.

If you don't have the time or the financial knowledge, properly managing your 401(k) can be a daunting task. And if you do not manage it properly, your 401(k) can become, at best, a savings account and, at worst, a high-risk gamble with your retirement money. While there is no step-by-step process for guaranteed financial success, following these steps will put you in a better position to make the most out of your 401(k).

Determine your investor profile.

Investor, know thyself! Before you can determine your asset allocation strategy, you must be able to clearly define your goals. Everyone has different dreams about retirement, and you may have some preretirement goals to save for. Separating them into different pools of money can allow you to seek varying investment options to help you fund each goal. Also, how psychologically comfortable are you with market downturns? Will you be able to tolerate the inevitable ups and downs of the stock market? Consider these variables when tailoring your plan.

Know your plan's options.

Your plan documents, distributed by your company's benefits department, will outline options such as hardship or in-service withdrawals, loans, vesting schedules, limitations to moving money and so on. Read this document carefully or have a financial advisor review it with you. If your 401(k) does not meet your investment needs, you may be able to move some of the money to other vehicles, such as an individual retirement account, where you may have significantly more investment options.

Fully participate.

The government, and by extension, your employer, give you the opportunity to take advantage of two very powerful financial concepts: the ability to save money on a tax-advantaged basis and the compounded growth of those dollars. To help employees increase the size of their nest eggs, as well as encourage reluctant employees to save, many employers offer matching funds. If your employer is willing to give you "free" money, take it. The only catch is that you must contribute some of your own money to receive the match.

Allocate appropriately.

With asset allocation, the idea is to diversify your holdings to potentially increase returns while diminishing risk. A variety of factors will determine the appropriate allocation for you: when you need the money (which is not automatically dictated by your retirement age), how much money you have now and expect to need later, what kind of risks you are willing to take and what other assets you have invested outside your 401(k). Perhaps the most important factor is your time horizon -- the more time you have, the more aggressive you can be.

Reallocate tactically.

While it's not advisable to move your money around daily, it's a good idea to check on your investments from time to time. If one segment of the market has significantly outperformed other segments, your portfolio is likely to be out of balance. A hypothetical example: You want 70 percent of your money in stocks, but during the past few months, stocks have grown to represent 80 percent. If you do nothing and the market goes south, you'll lose those gains and possibly more. Rebalance to make sure you again have 70 percent of your portfolio in stocks.

Limit exposure to company stock.

Company stock can be a double-edged sword. Perhaps your bonuses are gifted in stock, or as a loyal employee who understands the business, you want to become a shareholder. Either way, it can be risky to have too much of your portfolio in one stock. Do you really want the fortunes of one company to control your destiny? This is not to say your company will become the next Enron. But the question of what would happen if the stock suddenly tumbled 10 percent to 20 percent is worth asking.

Don't panic.

Listening to the evening news and hearing about the market's changes on a daily basis can cause even the most stalwart of investors to occasionally get nervous. The market is sure to experience downward dips and swings, which is why knowing how you'll react to those swings is a factor to consider in your overall allocation. Focus on the long term.

Consider tax consequences.

If you leave your current employer and decide not to leave your assets in your current 401(k), be sure to roll it over directly to an IRA or another employer's plan. If you instead take a full distribution, you'll pay federal and state taxes on the entire amount. And if you're not yet 55, you may also pay an additional 10 percent penalty. Meanwhile, if you are over 70½, you must follow the IRS rules for required minimum distributions (unless you are still actively working). Ideally, you'll take only what you need when you need it.

Borrow judiciously -- or not at all.

Many people believe (often erroneously) that if the interest rate on the 401(k) loan is less than what they would pay elsewhere, it's a good deal. That may be, but it does not take into consideration the real cost of the loan: the opportunity cost. The money in your plan cannot grow if it's not there. Before you take anything out, determine what that money would turn into if you left it in over the life of the loan, compared with what you'd be paying in interest elsewhere. Sometimes what seems like a good deal isn't.

Ask questions.

Managing a 401(k) or other retirement savings vehicle can be confusing. That's why it's important to be comfortable with asking questions if something seems complicated or too good to be true. Until financial services information is universally spelled out in apples-to-apples terms, asking questions so you understand the full scope of what you're signing up for can help you avoid issues down the road.

Make decisions when you're in a good frame of mind.

In the study, "Behavioral Finance and the Post Retirement Crisis," Harvard University professor David Laibson wrote, "After age 60, the prevalence of dementia roughly doubles every five years. By the time people reach their 80s, more than half will suffer from either dementia or other significant cognitive deficits." Even if we don't get one of these diseases, aging slows our ability to process numbers. We might shortchange ourselves if we wait to make important decisions about retirement until we actually get to retirement. If we can make these financial decisions when our minds are fresher, we stand a greater chance of making good decisions we can live with well into our later years.

Upon retirement, balance your needs for income and growth.

It used to be that you could retire and shift all your assets to fixed-income investments, but in today's low interest-rate environment, "risk-free" investments may also mean "growth-free." In other words, they may not even keep pace with inflation. As you stop working in retirement, it's time for your assets to work harder than ever. Risk can be a healthy and important part of a carefully designed portfolio and income plan.

Securities offered through SII Investments, Inc., member FINRA, SIPC. Advisory services offered through Scarborough Capital Management, a registered investment advisor. SII and SCM are separate companies. Neither SII nor SCM provide tax or legal advice. Opinions, estimates, forecasts and statements of financial market trends that are based on current market conditions constitute our judgment and are subject to change without notice. This material is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Investing involves risk, including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Past performance does not guarantee future results.



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