1. 1% increasing escalator
Many plans offer an option, when selected, that will automatically increase your contribution percentage each year up to a selected maximum. For example, if you are currently contributing 3%, you could sign up for the 1% escalator and set a cap of 15%. Each year your contribution percentage would increase by 1% until you hit 15% of your salary. This program could potentially add tens of thousands of dollars to your retirement balance over time.
2. Max the match
Many employer plans will add money to your retirement plan, potentially adding tens of thousands of dollars or more to your retirement balance over time, but there is a catch. To get the employer match, you have to contribute as well. Many plans will not add to your retirement plan if you do not. Generally the employer formula will have some sort of maximum employer match. For example, they may match your contributions of up to 5% of your salary. To maximize this match you must contribute at least 5%, in this example, to receive the maximum employer contribution. If you are only contributing 3%, you are leaving money on the table. Increase your contribution to the maximum employer matching percentage to receive all of the match. Check out this calculator to see the potential benefits.
3. Diversification:
Have you heard of the saying, “don’t put all your eggs in one basket”? Not only does this apply to eggs, but your 401K plan as well. If you have all your eggs in one basket and it drops, all your eggs may break. The same concept applies to your 401K plan. If all your money is in the same type of investment, and it goes down, your whole portfolio can drop. While diversifying may help reduce your risks, it is not a guarantee against loss. A prudent investment plan should include a mix of investments with asset classes that match your time horizon and risk tolerance. It rarely makes sense to have all of your money in one asset class.
4. Rebalance:
Most plans offer automatic rebalancing of your investment options on a periodic basis. Over time different asset classes, such as stocks, may outperform other asset classes, such as bonds. If this happens, you may find that your portfolio has more stock and potentially more risk than what you originally had selected. By taking advantage of the automatic rebalance feature, the plan would automatically bring you back to your original allocation, thus maintaining your original risk level.
5. Know your time frame:
A person who has 30 years to retire will likely have a very different mix of investments than a person retiring in 5 years. This is due to the potential risks of certain asset classes over others. The closer you are to retirement and possibly wanting to access your plan for income, the more conservative you should be. The further away from retirement you are, the greater level of risk you can assume. This is because your investments will have more time to recover if you experience a down market, whereas someone who is retiring soon, may have to delay their retirement if there is a significant drop in their portfolio. It is important that you periodically analyze your investment mix to ensure that it matches not only your risk tolerance but also your timeline.
Christian Bishop CFP®, EA