QuickTips: Make The Most Of Your 401(k)

Contribute the maximum allowed. Because of its tax-favored status, you may be able to contribute more than you think to your 401(k). For example, say you’re in the combined 35% federal and state income tax bracket. When you contribute $100, you’re actually foregoing only $65 in after-tax income, because the other $35 would have gone to taxes anyway. Plus, if your employer offers a match, say 50% on every dollar, up to 6% of your salary, that first $100 you contributed increases to $150. You contributed the equivalent of $65 in after-tax income, and ended up with $150 toward your retirement. So even if you can’t make the maximum contribution, at least contribute enough to qualify for your employer’s match.

Make informed investment decisions. Whether your employer offers ten or 100 investment options, your financial future depends on the choices you make now. Before you start zeroing in on specific funds, get your overall retirement plan in order and review all your plan’s informational materials. Then chose funds that best fit your overall plan. If your 401(k) offers only a limited number of funds, or only mediocre ones, choose the ones that come closest to your plan, and fill in the gaps with outside investments.

Go easy on your employer’s stock. If company stock is one of your 401(k) options, limit the amount you buy. You’re already dependent on your job for a paycheck and health insurance, so it’s not a good idea to also hitch your retirement security to your company’s future. How much is too much? One general guideline, borrowed from traditional pension plans, is that you shouldn’t invest more than 10% of your portfolio in any single stock.

If you don’t have control over how much company stock you hold, perhaps because your employer matches your contributions with its stock, direct the contributions you have control over into other plan investments. And whenever you’re given the chance, such as when retirement is approaching, switch some of your company stock shares into another investment.

Steer clear of market timing. If your 401(k) plan allows you to transfer money from fund to fund whenever you want by phone, resist the temptation. Study after study shows that trying to guess when to sell before a market downturn, and when to get back in before an upswing, or when to shift money among different investments, is a game even the pros seldom win. So it’s wisest to stick with your targeted plan, and you’ll likely come out ahead.

Do an annual check-up. At least once a year, rebalance your 401(k) portfolio to bring it back into line with your targeted asset mix. Shift money out of funds that have grown proportionately too large, into ones that have become relatively underfunded. For example, if stocks rose more in value than bonds over the year, you’ll have more in stock funds than your model portfolio calls for. So transfer some money out of your stock accounts into your bond accounts to keep things in balance. As an added benefit, you’ll automatically be making a smart investing move by selling high and buying low.

At the same time, check your fund’s long-term performance compared to similar funds, as well as to the appropriate benchmark indexes. For example, measure how your U.S. large-company stock mutual fund is performing compared to similar type funds and the Standard & Poor's 500 Index, and compare small-stock mutual funds to funds in the same class and the Russell 2000 index.