Friday, June 13, 2008

The 411 on 401(k)

Not all stocks are (obviously) created equally, and although I herald the benefits of investing, it's important to assess the risk involved, 401(k) included. It turns out, losing money in your 401(k) during some years is a good thing, according to J. Michael Scarborough, president of Scarborough Capital Management and author of 401(k) Knowledge. Scarborough argues that a "properly invested" person will lose money at times (in a 401k) because a smart investor needs exposure to stock funds to meet retirement goals (read: investing in the stock market, though it comes with risk, is a good thing, especially when done through a 401(k)).

For those of you who are still unfamiliar with how 401(k)s work, what happens is you set up a contract of sorts with your employer, specifying a certain percentage of every paycheck that will go directly into a mutual fund account (I opted for 3% per paycheck). That money gets automatically put into a mutual fund, where it is re-invested in certain stocks (associated with a general choice on your end of what type of investment you want the fund managers to be making -- perhaps an emerging markets plan, where they invest in overseas, higher-risk companies? Or perhaps you'd like a more long-term growth package? Etc., etc.) I chose the Growth and Income, lower-risk package.

The 401(k) investment does not guarantee returns every year. There will be down months and maybe even years, especially in today's dilapidating market, but the overall point is that in the end, you will have a hefty sum to pull out all for yourself once you're ready for the bluer skies of office-free life.

Selecting the right retirement plan can be tricky, and many like to fall back on their employers to make the decision for them. In most cases, companies leave the deciding up to you, though, to decrease the risk of them making the "wrong" decision and getting blamed (read: plethora of lawsuits). Scarborough says that currently, many workers could be making better choices by not, for example, "being loyal" and investing in their company stock, when the company doesn't really care. He says investing like this limits employees' diversification.

Scarborough also mentions that the worst thing an employee can do -- are you ready for it boys and girls? -- is to turn down an offer to participate in a 401(k) in the hopes that someone will come along and provide retirement moolah. This could include counting on finding a husband or wife to save for them, hoping that an inheritance will come to fruition right around when you plan on retiring, or that "someday" a big promotion will come along and make saving easier.

"To make the assumption that someone, somewhere is going to provide is a crapshoot," Scarborough says. "Retirement does, in fact, happen for most of us." The financial guru, in turn, says the biggest reform he'd like to see in 401(k) plans is that every employee would be required to sign up.

Still not sure about why you should save by investing in a 401(k)? Read my earlier article, "When I'm 64."

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