How to Invest Your 401(k)

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Investing in a 401k tax-advantaged account is one of the main ways that American employers save up for retirement. There are several reasons why it’s so popular. One is that the government allows you to put a certain amount of your paycheck into a 401k account without paying taxes on it.

The money you put in your 401k stays there and grows, tax-free until you retire and you have to start taking the money out. Then it is taxed, but by then you will likely be in a lower tax bracket.

Speaking of tax brackets, another nice feature of the money that you save into your 401k account is that it lowers your annual income. This might sound bad, right? Well, you are not taxed on that saved money, so it lowers the amount of your overall income tax as well. And everyone likes lower taxes.

A 401k is issued through your employer and they make it simple to enroll in the program. The problem is only about one-third of American employees use the 401k because they don’t want to save money. Most people can not afford to put off spending their income immediately. Don’t be like most people!

Embrace discipline and enroll in your 401k as soon as possible and stick to the program. The sooner you do it, the sooner you’ll be able to enjoy the benefits of compound interest.

A 401k is simply another type of savings account, and that is how you want to think of it, like a piggy bank. It is very similar to an individual retirement account (IRA) but since it is administered by your employer it comes with some extra stipulations. Once you invest money into the account you have the option to leave it as cash or to invest in stocks and bonds. You can only invest in the limited options offered by your employer’s plan and that is usually just a few crappy stock and bond mutual funds and a few exchange-traded funds (ETF).

But don’t worry. Get started savings because if you ever leave your job, or if you retire, you will have a lot more options of tax-protected things you can do with your savings. Now you may be thinking about how to move 401k to gold without penalty, or how to buy real estate with your IRA. Well, these are all options that are available to you, but they are outside the scope of this article. The point is, that you need to start saving in your 401k because once you leave your current employer, you will have tons of great investment options.

When you are employed and actively contributing to your 401k, your employer’s plan will most likely be managed by some huge financial corporation like Blackrock, Vanguard, Fidelity, or maybe Charles Schwab. When you leave your employer, your account will remain at this financial institution. You simply have to contact them and tell them where you would like to move it to, but you need to be careful to avoid taxes and penalties, so make sure you speak with an expert that knows what they are doing so you don’t lose a bunch of money.

The IRS lets you start making withdrawals that are tax-free when you reach the age of 59 and 1/2 years old. If you try to take out money before then, you get hit with a 10% early withdrawal fee.  And it gets worse. The IRS counts this money towards your income, so you get taxed on that. Isn’t that incredible? Isn’t double taxation supposed to be illegal? Yes, it is but the government does not care because the government allows the government to break the law. It is what it is.

You can learn more about withdrawals here:

It’s important to know, that not every employer offers a 401k plan, but do not worry. If you don’t have the option for a 401k from your employer, the only thing you’ll be missing out on is the employer match, where if you put in a certain amount, they will match that about by 25% or some other number. If you do not have this benefit at your company you can still save money the same way with a Roth IRA. This is money that has already been taxed as income, that can grow tax-free, and that you do not have to pay taxes on the investment gains. It’s almost as good as an employee match 401k.

Now that you have started saving money in your 401k you need to get used to taking risks. And what I mean is that you need to get used to your account going up and going down. As an investor you are going to see your account go in the red sometimes, this means your investment has gone down. Don’t worry about it. It happens all the time. What you want to do is get used to automatically contributing to your 401k at every paycheck. That way, you will always be buying and growing your nest egg. You’ll be buying when the price is down and you’ll be buying when the price goes up. This is called dollar-cost averaging and it’s one of the safest and most effective forms of investing that exist. Dollar-cost averaging is the only fool-proof method of investing.

What should you invest in?

Well, employer-sponsored savings plans have absolute garbage options for you as an investor. You’ll hear a lot of nonsense about this mutual fund and bond fund, yadda, yadda, yadda. Ignore all of it and put all your money into an index fund of the entire S&P 500. Buy the entire market because these funds have the lowest fees, and they give you the performance of the market. Anyone that tells you differently is just trying to get as much money from you as they can in management fees.

Experts advise keeping it slow and steady. Max out your tax-free contributions at every chance you get. If you can put your entire bonus in your 401k do it and you’ll be happy. If you don’t, the IRS will take a gigantic chunk of that bonus.

Hopefully, you have found this article useful and you’ll get started saving money in your 401k today. You’ll be surprised at how fast it will grow.

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