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Five Steps Investors Can Take Now to Protect their 401(k) Plans
401(k) Plans: Too Many Choices?
As more (and riskier) investment options proliferate within 410(k) plans, it has become increasingly complex for individual account holders to allocate investments. Theoretically, more choices should yield customized plans tailored for the individual to meet his investment goals. Paradoxically, a plethora of choices often leads to confusion.
401(k) Investing: A Balancing (and Re-balancing) Act
Most 401(k) investors do not actively manage their accounts, reallocating as market conditions change. After all, the intent of the legislation that created the 401(k) program, and the general perception of it, is that 401(k) investments are for the long term, and should not have to be constantly monitored by individual account holders. However, the mix of investments suitable for a 21-year old is quite unlike that most appropriate for a 55-year-old nearing retirement.
How Can Investors Protect Their Savings?
Apart from waiting for possible legislative changes that are being debated by think tanks, politicians, and lobbyists, which may or may not be well-received by the public, here are some steps investors can take now:
- Do not liquidate a 401(k) plan. Payouts taken when closing a 401(k) are subject to a 10% early withdrawal penalty, and the funds are taxable in the year they are withdrawn. Although the value of a 401(k) might continue to decline in the immediate term, there is no chance of making back any of the loss of a closed account when the market strengthens. If a layoff results in ineligibility to continue in a 401(k) plan, avoid penalties and taxes by rolling it over to one of the IRA options instead of cashing out.
- Do not borrow from a 401(k) plan. There are a few circumstances under which borrowing from a 401(k) make good financial sense, buying a home being the most common, but in general, do not use a 401(k) as a source of funds for everyday living expenses. The moment funds in a 401(k) are converted to a loan, they stop earning returns for the investor and begin racking up interest charges. And dont even think about 401(k) debit cards--an invitation for impulse-spending if ever there was one.
- Read, read, read. Get smart about what is going on in the world in general; world news shapes financial markets responses which in turn impact 401(k) plans. There are many excellent sources of general news with a financial slant, in print, broadcast, and online including The Economist, CNN, and the Wall Street Journal. Making intelligent allocations is not just about choosing small cap stocks versus large, but about paying attention to current events and spotting and understanding trends.
- Understand the broad categories of investment choices available in 401(k) plans. These categories include stocks (equities), bonds, and mutual funds. There are hundreds, if not thousands, of sources for financial education including newsletters, Web sites, and advisors. A few hours of time spent researching can yield a wealth of information to help with allocation decisions.
- Be proactive in reallocating investments. Most 410(k) plans allow frequent reallocations. Take advantage of this flexibility by scheduling regular reviews of 401(k) plan performance and reallocating based on knowledge of world and financial markets.
Until 401(k) plans are replaced by some other retirement investment vehicle or unless allocation decision making is put in the hands of employers instead of investors, it is in investors best interest to become more proactive in managing their 401(k)s.
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