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How to Make Your 401(k) Selections in 5 Simple Steps

One of the most popular retirement accounts in America, a 401(k) is an employer-sponsored tax-advantaged retirement savings plan that allows investors to save tax and build a substantial retirement corpus at the same time. Opening a 401(k) account and contributing to it on a regular basis is a hassle-free way to save for your retirement. Many people start their 401(k) investment journey early in their careers to save money and build a sizable corpus to live comfortably in their retirement years.

Although the process of how to invest in a 401(k) is fairly straightforward, not all 401(k) account holders understand how exactly these investment instruments work.

The contributions you and your employer make in your 401(k) account grow over time when invested in return-generating asset classes like stocks, mutual funds, bonds, debt, and money market instruments. The investments are generally handled by the fund manager. However, you do have the option to make your own 401(k) selections and choose the asset classes you want your savings to be invested in. If you need help with making the right 401(k) selections based on your risk profile, investment horizon and future goals, reach out to a professional financial advisor who can advise you on the same.

In this article, we will explore how you can make these 401(k) selections, why they are so important, and what you should keep in mind before making 401(k) selections.

How to make your 401(k) selections in 5 simple steps

When making 401(k) selections, you may feel a little overwhelmed and wonder how and where to begin. To make this process easy and hassle-free, here is a 5-step guide on making 401(k) selections:

Step 1: Start with your company’s plan document

The plan document or a company’s business plan is a detailed guide to the company’s retirement plans, policies, vesting schedule, ESOP plans, and 401(k) employer match policies, among other aspects. This makes the company’s plan document the right place to start the process of best principal 401(k) investments.

The vesting schedule is the most important thing to look for in this document. The vesting schedule states the date when the contributed amount by you and your company in your 401(k) account will be yours. Some companies may require employees to be on their payroll for a certain period of time before the money contributed to their 401(k) account will be 100% theirs.

Thus, refer to the plan document to understand your company’s vesting schedule, what fees are levied on your 401(k) account, and the services you can avail. More importantly, you will also get to know how to make changes to your 401(k) portfolio via the plan document.

Step 2: Fill out the ‘Beneficiary Designation Form’

If you have purchased life or term insurance plans, you might know how the beneficiary program works. You choose a person from your family or next of kin who will be the beneficiary of the funds. This can be your spouse, children, parents, grandchildren, or others. Essentially, your designated beneficiary would get the funds from your 401(k) account in case of your death. However, a lot of people skip filling out the beneficiary form. Many also forget to update the designated beneficiary form in case of divorce, disputes, or deaths.

Hence, ensure that you fill and update the designated beneficiary form when considering 401(k) investment options.

Step 3: Fill out your ‘Plan Enrolment Form’

Considered to be extremely important, the plan enrollment form entails allocation of a certain percentage of your paycheck to your 401(k) account for retirement savings.

At this stage, you may decide whether you want to have a traditional 401(k) account or a Roth 401(k) account. In a traditional 401(k) account, you contribute pre-tax dollars and pay taxes when you make withdrawals as per the prevalent tax rate in that year. In a Roth 401(k) account, you contribute post-tax dollars and need not pay any taxes upon making a withdrawal.

Ideally, Roth 401(k) accounts have significant benefits. Thus, check with your company if they have the option of choosing Roth 401(k). Also, you may be asked to consider automatic rebalancing.

Automatic rebalancing for 401(k) selections refers to rebalancing of your 401(k) portfolio once a year. This requires selling high-performing assets to realize gains and buying low-priced assets with immense potential. Rebalancing ensures that your portfolio is assessed for risk, and allocations are made in a way that protects your retirement savings from being eroded.

Step 4: Educate yourself about investment options

Before making 401(k) selections and allocations, you need to educate yourself about the investment options you have at your disposal. You can refer to your plan enrollment form for this and study the investment options provided by your 401(k) plan manager. The form will provide ample information about each investment option to make an informed decision. However, you can also study your options and choose the most lucrative ones that meet your risk appetite.

Bonus tip: Do not skip reading about target-date funds when going through your investment options in the plan enrollment form. These funds have various asset classes depending on the date of your retirement. For instance, if you are far from your retirement, the asset class will be a mix of stocks and mutual funds, but when you are close to retirement, the fund would divest your equity options to buy more conservative assets such as bonds to avoid high risk.

You can avoid having any target-date funds in your 401(k) portfolio and make selections per your volition and expertise.

Step 5: Make the right 401(k) selections

In this step, you select your 401(k) investment options. You can choose from mutual funds, individual stocks, debt, money market instruments, and more.

The key here is to understand what is the right asset allocation strategy according to your goals, investment horizon, risk appetite, and liabilities. Even if you understand each asset class thoroughly,  an experienced investment advisor can help you get your asset allocation strategy right. For example, you may invest in index funds, growth funds, international funds, balanced funds, hybrid funds, bond funds, etc. Investment advisors can help you make the best principal 401(k) investments and enable you to safeguard your interests at a reasonable cost.

Things to keep in mind before making 401(k) selections

Although 401(k) selection may seem like a straightforward process, there are a few factors you ought to keep in mind to make the best choice:

1. Understand how a 401(k) account works

Despite contributing to a 401(k) account, there are many folks who may be unaware that you can modify the investment selections. Hence, it is important to understand how a 401(k) account works, its features, and how you can use them to generate maximum returns.

2. Factor in your risk appetite

Consider your risk appetite before you make changes to your 401(k) allocation or make fresh 401(k) selections. You can increase the allocation to stocks and mutual funds if your risk tolerance is high. This may need to be revised once you start getting closer to retirement as your risk appetite may dip, and you may want to reconsider the allocation and switchto more stable bonds and debt instruments.

3. Do not neglect your age & investment horizon

FIgure out the age at which you would ideally like to retire and then consider your 401(k) investment options. This will help outline your total investment horizon and ensure that your retirement savings plan is in line with the number of working years that you have left. This can also help you identify when you should invest in high return-generating, risky asset classes and when to switch to safer, capital preserving asset classes.

4. Define the amount of funds you need for retirement

Based on your lifestyle, spending habits, and needs, determine the sum of money that you would ideally need for a comfortable retirement. Once you have a retirement sum in mind, you can better devise strategies and make 401(k) selections that will help you reach that sum faster.

5. Level of diversification needed

If you have invested in other asset classes outside of your 401(k) account, ensure that your overall investments for 401(k) are diversified. For example, if you have invested in tech stocks outside of your 401(k) account, ensure that there is minimal concentration of tech stocks in your 401(k) account. Similarly, ensure that the mutual funds you have chosen are not tech growth mutual funds to avoid concentration of your funds in one asset class.

To summarize

401(k) investment accounts, when used right, can help you generate an incredible amount of money for your retirement. They can also help you save enough to be able to retire early. The important part is to find out where to invest, when to exit or enter certain investments, and how long to hold them.

A certified investment advisor or a financial advisor is best suited to help you make the right investment decisions vis-a-vis 401(k) selections. The advisor can help create a customized 401(k) selection strategy based on  your requirement, goals, and investment horizon.

Use the free advisor match tool to match with an experienced and certified financial advisor who will be able to guide you effectively on effective 401(k) asset selections and create an effective investment strategy that will allow you to attain your financial goals. Give us basic details about yourself, and the free match tool will connect you with 1-3 professional financial fiduciaries that may be suited to help you.

The blog articles on this website are provided for general educational and informational purposes only, and no content included is intended to be used as financial or legal advice. A professional financial advisor should be consulted prior to making any investment decisions. Each person's financial situation is unique, and your advisor would be able to provide you with the financial information and advice related to your financial situation.

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