Five minutes is all it takes to make sure you stay on track financially
I was just out on the West Coast and stopped in Denver on my way back to Florida so I could spend the day with my son and his girlfriend.
He had only a day free between flights (he’s a pilot) and I had not seen him in a while, so I was grateful to squeeze in some time – even less than 24 hours – to check in and visit.
At thirty years old, he’s made that quantum leap into adulthood that seems to come a little later for guys. He’s now on a solid career and relationship trajectory, moved into a new rental townhouse, bought a 4 wheel-drive vehicle suitable for the Colorado weather, and – wonder of wonders – actually sent me a combination birthday/Mother’s Day card ahead of the date (OK, I know his girlfriend reminded him and picked out the card that says “From Your Son” but I’m not complaining).
Time for a 401(k) check-up?
Another sign of adulthood? He’s enrolled in his company’s 401(k). So no surprise that, being a financial planner, I told him I wanted to do a check-up on his 401(k) during the less than 24 hours that I was in town.
Fortunately, he welcomed the free advice and pulled up his account on the computer to do a quick once-over. There were two items in particular I wanted to look at with him. The first, how much he is contributing to his 401(k) expressed as a percentage of salary. The second, how his contributions are invested.
It took us less than 5 minutes to review the account and process the changes he needed to make. You can review your 401(k) account – and make sure you stay on track – by spending no more than 5 minutes each quarter.
Three simple steps to make sure you stay on track
Here’s what you want to do:
Step One: Make sure you can sign into your account online and have activated two-factor authentication to keep your account safe. Sounds dumb, right? But some people are unfamiliar with the logon process, forgot their password, or for some reason can’t sign into their accounts. Make sure to activate two-factor authentication (basically a second layer of security requiring you to identify yourself) or another similar cyber-safety protocol if offered (ask the plan administrator) and keep passwords safe by using a password manager app. Scribbling the password on a post-it note stuck to your desktop is not a great idea!
Step Two: Check your contribution level. This is how much of YOUR salary you defer (or choose not to receive) and direct into the 401(k) plan instead. As a fairly junior and cash-poor employee, my son was deferring 4% of gross salary. He knew that was too low, and now that he is feeling more comfortable with his cash flow, he agreed to bump it up to 8% of gross salary. Your contributions are usually calculated in dollar terms or as a percent of GROSS salary (before all taxes and other deductions).
As financial planners, we want people to save a target of 10-20% of gross salary. Assuming your employer kicks in another 3 to 5% of their money (not yours), your total savings might be about 13 to 25% of income. A recent Wall Street Journal article reported that average 401(k) savings rates at plans managed by Fidelity Investments are now up to a new high of 14.3%. That’s really good news. For years, Americans have been chronic undersavers.
So do look at your contribution level. Try to bump it up toward the 10 to 20% level. If you’re on the low side, add 1% more if that’s what you can afford, but if your budget can accommodate it, do more. You probably won’t even notice the difference in your paycheck. If you make the changes online, they’ll normally take effect with your next paycheck. I made a note to check back with my son in 3 months to see if he can increase his contributions further. The sooner he gets to the target level the better, as saving money now is better than saving later. Today’s savings have more time to compound and grow over time, which is where the real magic takes place.
Wondering how much you can contribute of your own money? The annual maximum is $23,500 up to age 50 by year-end. If you are 50 or older at year end, the max is $31,000, with even higher amounts if you are between 60-63. (Who writes these crazy rules, anyway??). Most plans will cut you off if your contributions exceed the max, but check with your plan administrator (usually an 800 number on your online statement) if in doubt.
Traditional vs Roth 401(k)
To keep it super simple, I’m not focusing today on the question of whether to contribute to a traditional or Roth 401(k). Some plans allow you to choose or mix & match. Some plans offer only traditional 401(k) contributions.
Traditional 401(k)s – the kind around since 401(k)s first started – allow you to defer salary pre-tax. You are NOT taxed on the salary you defer to your 401(k) plan. Therefore, contributing to the 401(k) helps you cut taxable income and current taxes. It allows you to postpone taxable income until a future date. Hopefully, by then you’ll be retired, not working, and will be in a lower tax bracket. (Again, the key word is “hopefully.”)
Roth 401(k)s are newer. Many companies do not offer them yet, but as noted, larger companies with more sophisticated record-keeping allow employees to split contributions between traditional and Roth 401(k)s.
So why do a Roth 401(k)? Roth 401(k) contributions are made with after-tax earnings, meaning income you have already paid tax on. Future growth and qualified withdrawals are tax free. These are better for younger employees or those with lower taxable income or in lower tax brackets, because they are not paying a lot of tax now but may be wealthier (and in a higher bracket) in the future. We’ll cover this more in depth in a future article.
And finally, let’s check the investments
Step Three: Review your investment allocation. Allocation is our fancy word for the mix of investments – typically stocks and bonds – in your account. The key to investing in your 401(k) is usually KISS, or “Keep It Simple, Stupid.” Don’t get tricky. Don’t overthink it. Don’t show off (like who cares anyway?). Just get it invested using a reasonable allocation tailored to your objectives and time horizon and leave it alone.
My son made a smart choice. He’s invested 100% in a target-date fund offered in his plan. The “target-date” is roughly his retirement date. In his case, that’s 2060, or 35 years from now when he will turn 65 and we assume will stop working.
A target-date fund is a good place to start. You can always change your allocation down the road, but a target-date fund at least gets you invested in a fairly low-cost, vetted, diversified mix of stocks and bonds suitable for someone your age. For example, the 2060 fund in my son’s plan is about 55% U.S. stocks, 35% non-U.S. stocks, and 10% bonds and cash. (Be aware that target-date funds managed by other companies may have different allocations, or stock/bond mixes. Everyone does it a little differently). The general consensus is that younger investors, like my son, have a long time horizon (35 years), a need for long-term growth in their account balances, and a tolerance for risk (ups and downs) since they won’t be tapping the account until retirement. You may have different investment goals or circumstances and need a very different approach.
And of course, you don’t have to use a target-date fund. You may have a better idea in mind. But what I like about target-date funds is that they get you invested quickly in something roughly appropriate. Much better than sitting in cash for months while you think about what to do (a too-common female mistake) or going all-in with the latest hot stock trend (a familiar male move). Stereotypes aside, keep it simple. Just get invested, forget trying to time the market, and move on. It’s not that important.
To sum it up….
The point here is you can do this entire 401(k) check-up in just a few minutes. It doesn’t require much in the way of specialized knowledge. If you need more help, look at the guidance offered by your plan administrator (many offer Investing 101 basics on their website) or talk to an advisor. But even a few minutes per quarter will help keep your finances on track, improve your investing confidence, and encourage hands-on engagement in managing your finances. Those are good things for all investors, and especially for women who quickly learn that financial freedom gives them more choices in life.