Time to Take a Peek at Your 401K Plan and Reevaluate Your Choices

It’s almost the end of January and by now you probably know what your take-home pay will be after all of the deductions for taxes, medical insurance, social security, and any 401K contributions you are making. However, if you haven’t put together a budget yet, you should probably do that now, and don’t forget to include the contributions to your 401K as well. If you have access to a 401K plan through your employer, you should be participating already – if not, it’s time to start – no excuses.

For those of you already making contributions to your 401K, it’s time to evaluate and potentially make some adjustments.

Increase Contributions

It’s possible you got a raise this past year or will get a nice end of year bonus. Other than using that money to take a vacation or buy that item you had on mental lay-away, you should also think about giving a boost to your retirement account.

If you’re already contributing the amount that gets you the maximum contribution from your employer, that’s great, but so what??? It’s going to be up to you to fund the retirement you envision in 10, 20, or 30 years, so it’s in your best interest to contribute as much as you can and as early as possible. By the way, if your employer DOES match, you’d be walking away from free money if you don’t get the max contribution.

In 2020, the IRS limit for 401K contributions was raised to $19,500, and if you are turning 50 this year or are already there, you can contribute another $6,500. You might not have the cash flow to maximize your contribution this year but you should dig deep and figure out if you can squeeze out another percentage or two from your paycheck. It will benefit you in the long run.

And another point to note about an increases in your contributions to your 401K is that for every dollar you contribute, your paycheck declines by less – due to the tax benefits of plan contributions. A simple example is that if you’re in the 20% tax bracket, for every $1 you contribute to your 401K, your paycheck will only decrease by 80 cents. (this could be impacted by your W-4 options and other factors) Yes, it’s still less money in your pocket but you’re increasing your 401K by $1 and it’s only costing you 80 cents.

Check your Asset Allocation

Your asset allocation is the percentage of your 401K funds invested in stocks vs. bonds, or large cap vs. small caps, or US equites vs. International equities. The allocation you choose has implications for the risk and returns of your portfolio over time. If you want higher returns, you generally must take higher risks, but there are methods you can implement to try to maximize returns for a given level of risk.

You want to make sure you know if you’re investing correctly. Not only will you be exposed to short-term losses if you are positioned too risky, you also risk not reaching your retirement goals if you are positioned too conservatively. If you’re young and have a long time horizon ahead of you AND you don’t mind higher levels of volatility (fluctuations in the value of your account), you should be positioned more aggressively with a higher percentage in equities. If your time horizon is shorter and/or you can’t stomach seeing big negative drops in the value of your account (even if only temporary), then you should be positioned more conservatively. That means a lower percentage in equities and a higher percentage in fixed income. Check it out HERE.

Rebalance Your Investments

The other thing you should probably do with your 401k is rebalance your allocation. It’s highly likely that if you’ve never rebalanced, you have a much higher percentage to certain funds than your contribution allocations. For example, if you were contributing 50% to Fund A and 50% to Fund B from every paycheck, if both funds had the same performance, the total you currently have invested in each fund will be roughly 50%. But if Fund A performed better over time than Fund B, the percentage of your 401K in Fund A will be higher than 50%. In some cases, it could be much higher. And while you might be thinking this is a good thing, it actually exposes your investments to risks that you may not have intended. Most 401K plan providers make it easy to log into your account and reset the percentages back to their original intended state. This process of rebalancing often leads to buying low and selling high.

Reevaluate Your Fund Choices

In some cases, the funds you chose performed better than some of the other fund options in your plan. In other cases, they may have performed worse. Now is a good time to evaluate your investment choices and determine if you need to make changes. I’m not suggesting you sell any bad performing funds and invest in good performing funds based on recent performance. This would be like driving forward by looking through the rear-view mirror – it could end in disaster.

One suggestion is to compare the funds in each category, such as Large Cap Growth, and evaluate whether your current choices are still valid. One way to evaluate a fund is to look past just the one or three year performance data and look at the longer term performance – maybe 10 years or more. You might also ask yourself why some funds performed better than others and whether performance might change going forward. If you don’t know how to determine that yourself, a representative from your plan provider should be able to provide you with some guidance, or find your self a Financial Coach

Next Steps

If you know your login information to your account, explore the site and any information it provides about asset allocation, the mutual fund choices available, and how you can increase your contribution and allocations. If you don’t know, reach out to your HR person and they could probably point you in the right direction so you can access your account.

Reach out to a professional advisor and have them take a look at your account and see if it is invested in a way that is consistent with your financial goals and objectives. Some advisors may not advise on 401K plans but others may charge an hourly or fixed fee to give you their two cents worth.

Whatever you do, don’t set it and forget it when it comes to your 401K. While you don’t necessarily have to look at it monthly or quarterly (I recommend quarterly), you should at least glance at it once a year to make sure it’s positioned correctly for your unique circumstances. Keep in mind, both your circumstances and the balance in your 401K change – an annual review will at least ensure they are aligned.