How Should I Invest My 401k?
When it comes to the world of investing there may be no bigger question plaguing the average American than what to do with you 401(k). For a lot of people, the question goes deeper, and results in them wondering exactly how risky should they be with it?
While it is true that how risky you should be with your 401(k) is largely dependant on how close you are to retirement age, there are some simple truths that can serve as advice for nearly everyone.
Much like everyone knows that when it comes to stocks and investing you want to buy low and sell high, with a 401(k) you do not have to worry about making sure you are buying only when the market is low, or fussing over what to do if things are high.Because of the nature of a 401(k) there is no need to worry about timing your investments with it.
One of the most important things to remember when dealing with your 401(k) is that the money you are putting away into it, and investing into it is going to be held up until you do retire, because there are significant tax penalties that come into play if you need to take this money out before you reach the age of 59.5.
With these tax penalties in mind, it is also important that you are not planning on using the money in your 401(k) as funds for emergencies. Instead, you should invest in having other funds available in these situations. Ones that are much less risky, and liquid.
How Much Time Do You Have
Before you even get started with deciding how risky you can be with your 401(k) you need to have a good, basic understanding of how much time you have left in which you can invest.
As a basic rule, if you are within 10 years away from being retired, you are going to want to invest a little more safely and generally avoid risk. However, if you have 30 or more years before you are of retirement age you have plenty of time and can move forward allowing yourself to take a little more risk when it comes to investing and dealing with your 401(k).
There is a general rule of thumb for those who have a lot of time before their retirement that says you should work on selecting index funds in order to help yourself be much more diversified. The basic idea here, when it comes to your 401(k), is that since you are far away from retirement you have more time to be risky and get more rewards. Whereas, if you are close to retirement, you will want to play things a little more safe.
Dollar Cost Averaging
Your 401(k) has the advantage of dollar cost averaging built right into it, and if you are in a situation where there is plenty of time for you to use this to your advantage you should do so.
The key to doing this is continually contributing to your 401(k) no matter what the market is up to. Because you are continually buying and selling (both at highs and lows) your investments will average out over the time before you retire. This takes away the stresses of trying to make sure you buy low and sell high all of the time, and instead allows you to take a hand in there mentality if things go bad for a period of time.
However, if you do not have a lot of time before you retire, you may not have enough time for dollar cost averaging to benefit you. This means you will want to be a lot more sensible with the allocation of your risky investments.
Do Not Chase Returns
One of the number one things you will want to avoid doing with your 401(k) is chasing returns. Instead, you will want to make sure you pick out some solid index funds, and if you are planning on using your 401(k) as your main, long-term retirement funds, invest passively, with little risk.