Last Updated Oct 12, 2011 2:36 PM EDT
Consider Roth 401(k) Contributions
Some plans will also allow participants to use a feature called Roth 401(k) contributions. These contributions are deducted from your after-tax pay. But the big advantage is that when the money is withdrawn at retirement, all of it is tax free! This is a significant benefit to younger workers who will be investing for a long time and thus will have a large amount of growth on their retirement savings. If your plan offers this feature, and more plans are doing so, then strongly consider make some or all of your contributions in the form of a Roth 401(k) contribution.
If you absolutely can't afford to save 10 percent of your pay right now, then begin with at least the contribution rate required to receive the maximum employer matching contributions, which is six percent in most employer's 401(k) plans. But don't stop there. You should also activate a feature that will automatically increase your contributions each year. Many 401(k) plans include such a feature called the automatic contribution escalator. The way this works is that you can set it up to automatically increase your contributions by a defined amount on a pre-set date in the future, such as when you get an annual increase in your pay. Most workers will get a pay increase each year and the historical real wage increase in the US is about 1.5 percent per year.
Also, once you set your investment elections, you can activate another automatic feature. The automatic rebalancing feature will automatically reset your portfolio to the percentage allocations you selected for the stock and bond funds you selected when you signed up. I suggest setting this feature to rebalance your account quarterly.
Invest for Maximum Growth
According to major 401(k) plan service providers, younger employees invest retirement accounts more conservatively than their parents - allocating only about 38 percent of their accounts in equity funds with the remainder allocated to lower risk balanced, bond and stable value funds. Studies show that about 20 percent of workers in their 20's have no stock investments in their 401(k) accounts. One reason for this could be that most of their experience with stock funds included the period of 2007 through 2008, when the stock market losses negatively impacted their accounts. But the younger you are, the more time you have to save and invest and the majority of your retirement account and future contributions should be allocated to stock funds. If you look at the performance of the financial markets between the periods of 1956 through 2005, a 100 percent stock allocation generated an average annual return of 10.4 percent, but a 60 percent stock and 40 percent bond allocation generated a return of 9.1 percent. While this may not sound like a lot, over time this can make a huge difference in the amount of money a younger person could have at retirement.
Reach This Milestone by Age 30
According to experts and a study by Fidelity Investments, by the time you are age 30 you should have accumulated 1 to 2 times your annual pay in retirement savings and you should be saving 10 percent or more of your income in your 401(k). This assumes you are looking to retire at age 65 and earn an average income.