Feed This Little Piggy Properly
Year-end TLC can keep your 401(k) growing while avoiding needless risk
When it comes to managing their 401(k)'s, American workers are neither naughty nor nice. They're simply neglectful. Still, the odds are slim to none that jolly ol' St. Nick will come down your chimney with enough money for a long, happy retirement. So 2006's final weeks are a smart time to reacquaint yourself with your retirement accounts.
Start by seeing how much of your retirement contribution your employer will match. "Contribute at least up to that amount," says Rande Spiegelman of the Schwab Center for Investment Research. "Otherwise, you're leaving free money on the table."
Then, challenge yourself to contribute more. Since 401(k) contributions are made with pretax dollars, it could cost you as little as 70 cents to stuff $1 into your account, depending on your tax bracket.
Try boosting your payroll deduction by a percentage point or two. See how your take-home pay is affected. If the sting's not so bad, kick in a little more. "If you go slowly, you'll hardly feel it," says Christine Fahlund, senior financial planner with T. Rowe Price.
Cap gains. If you can afford to sock away more, remember that the annual cap on 401(k) contributions has been rising. This year, the ceiling is $15,000; in 2007, it will be $15,500. Workers 50 and older can salt away an additional $5,000 a year.
Next, rebalance your mix of stocks and bonds to avoid risk.
Why? Say you invested 60 percent of your money at the start of this decade in the Vanguard 500 fund, which mimics the Standard & Poor's 500 index of blue-chip companies, and 40 percent in the Vanguard Precious Metals and Mining Fund, which invests in gold-mining stocks. Had you left your portfolio alone, it would have morphed into 65 percent gold/35 percent S&P 500 by the end of 2004. That's way too risky for most investors. Yet between 2000 and 2004, 60 percent of 401(k) investors failed to rebalance even once, according to Hewitt Associates.
Here's a simple way to rebalance: Sell some winning stocks, and put that money in areas that haven't done so well. Because retirement accounts are tax sheltered, selling doesn't trigger capital gainsor taxes. Don't want to sell? Simply change your 2007 elections so more money goes into the laggard investments.
Or put the rebalancing on autopilot.
You've got several options. For starters, roughly a quarter of 401(k) plans offer automated rebalancing. If you choose to maintain a 60/40 mix of stocks and bonds, the plan will bring your account back to those proportions annually.
Increasingly, 401(k) plans offer access to an investment management service. In a managed 401(k), all you need to do is request the service and answer a few questions. Then, a firm such as Morningstar or Financial Engines will invest your money, for a fee. It determines your asset allocation between stocks and bonds. It picks your funds. And it rebalances your portfolio.
Another option is a life-cycle fund. These single funds invest in a mix of stocks and bonds. Then, at least once a year, the portfolio managers rebalance the holdings.