Although it might seem like a chore, reviewing your 401(k) from time to time doesn’t have to be painful. The best way to save for retirement is to let things run on autopilot, but you can’t completely set-it-and-forget-it. A periodic review will help ensure that you’re on track, and you can review the most important items in less than an hour.
How often should you review your 401(k)? That depends. If you’re more than 10 years away from retirement, every 6 to 12 months is plenty. The closer you get, the more often you should check, double and triple-checking that things are working according to plan.
More than ever, you’re on your own when it comes to retirement income. So here are some of the most important things to keep an eye on.
How Much Risk Are You Taking?
Are you taking the right amount of risk? You’ll want to ensure that your retirement savings are invested in a way that will help you reach your goals. Whether you’re an aggressive or conservative investor, make sure that the investments in your account actually match your investing personality.
In very general terms, you probably have the ability to invest in stocks, bonds, and cash. The amount of risk you’re taking (and the type of risk you take) is determined by how much you have in each type of investment. If most of your money is in stocks, you’re taking a lot of risk. Investments in bonds and cash can help reduce market risk, but bonds can lose money and inflation can eat away at your purchasing power.
As time passes, you might want to adjust your account. For example, you might reduce the amount of stock exposure in your 401(k) as you approach retirement (the idea being that you don’t want to take a big hit right before you start spending that money). You’ll probably want to keep at least some money in the stock market – because hopefully you’ll be spending that money for decades – but there’s nothing wrong with making small adjustments as your life changes.
Are You Diversified?
Evaluate your investment mix. Do you know where your money is? Is it in a variety of places, or are you exposed to just a handful of investments?
Diversification, which happens when you spread your money out into a variety of investments, is the closest thing you can find to a free lunch. You can certainly lose money with a diversified portfolio, but it’s the best way to improve your chances (even if just a little bit); diversification can help you improve returns while at the same time reducing volatility.
To diversify, you’ll need a broad mix of investments, including stocks, bonds, and cash. Furthermore, you’ll want to spread things out within each of those types of investments (large-company stocks and small-company stocks, government bonds and corporate bonds, home-country stocks and foreign stocks, etc.). If you don’t know how to do this, ask for help. Your 401(k) provider or a financial planner can guide you in the right direction.
In most 401(k)s, the easiest way to diversify is to use an “asset allocation” fund. Those funds generally invest in many different underlying funds (providing diversification). They might even adjust over time – getting more conservative as you approach retirement. Asset allocation funds are not perfect, but they are often a good solution for hands-off investors. Just be sure to understand the funds available to you, and the pros and cons of using them. Don’t pick a target date fund based on your birthday alone – take a closer look at how funds are invested and whether or not “your” fund takes the right amount of risk.
What Fees do you Pay?
You might not have much control over fees, but there are some things you can do to minimize what you pay in your retirement accounts. Plus, as a savvy consumer it’s always better to know than to not know.
Start by looking at your investment expenses: are they too high? Some companies offer expensive 401(k) plans. Paying those costs may be better than not having a 401(k) plan at all, but sometimes those costs get unreasonable. The fees that you pay should be shown on your quarterly statement or as part of an annual disclosure document. If your 401(k) plan is too expensive, don’t stop saving – just save elsewhere. Contribute enough to get the full employer match (if there is one) and then look at individual retirement accounts (IRAs).
Pay attention to other fees that you might pay in your account. For example, you might pay short-term redemption fees if you get in and out of investments frequently. Do you really need to trade that often? Loan servicing fees are another example. Can you pay off your loan early to avoid paying an annual fee (and get your money back into the markets for potential long-term growth)?
Is the Right Amount Going In?
As you review your 401(k), compare the monthly additions to your account with the amount that is deducted from your paycheck. Make sure those amounts match, and that you’re saving as much as you thought you were saving. Sometimes employers make innocent mistakes, and sometimes nastier things are going on. It’s important to catch problems early, especially if your employer is on the verge of bankruptcy.
The “right” amount might also be the amount you need to reach your goals. Are you saving enough, or is this a good opportunity to increase the amount you save each month? Perhaps you won’t even notice if you increase your contribution by 1% (although a bigger increase will help even more). Do some basic retirement planning so that you know what to expect when you reach retirement – and what you can do if you want to change things.
Readers: what else should you look for as you review your retirement accounts?
Photo credit: mjtmail (tiggy)