Congratulations! You have been selected out of the hundreds of applications and you have just started your new career. As part of the new hire process, with most companies, you will be asked to enroll in the company’s retirement plan.
This can be a treacherous task, especially if you are new to the work force, but with a little know how you will be able to get set up in a flash. Depending on how whether your company is “For Profit” or “Non-Profit” the type of account can vary. This should be irrelevant for the most part in setting up your account for the first time.
Now is the time to make some considerations:
1) You are saving for your RETIREMENT- You are not saving for a new car, a vacation, a boat, etc. Therefore when working on your retirement plan [Think] Long-Term.
2) You need to decide what degree of risk you are comfortable with. Again think long term here, you are contributing money to an account that you will not withdraw for many years. Risk=Reward but it can also equal Loss. The stock market will go up and down, it always has and always will. You will have some years where you lose money and some where you gain. You should not be overly concerned with taking on more risk [Think Stock Funds] especially when you are young. Whatever you decide at the beginning [In most cases] can be changed at a later date, should you change your mind.
3) You need to figure out how much you can afford to contribute. The Current IRS Maximum is $18,000 and if you are over age 50 you can contribute an additional $6000. That being said, in reality only a small percentage of people can afford to max out their retirement plan. At a bare minimum you need to contribute enough to AT LEAST get the full employer match if one is offered.I always recommend contributing at least 10% of your salary [unless that places you over the limit.]
4) Expenses: Not all investments are created equal. Nearly every investment has some sort of “fee.” Typically in an Employer Plan you are mainly facing the expense ratio. This is an estimated expense of what it costs to run that particular fund. As you look through the offerings keep an eye on the expense ratio. Funds that are more actively managed will have higher ratios than funds, that are not. The expense is already factored into the displayed return for the fund, so you can easily see what the real return is for that fund. Keep in mind that certain plans may charge an admin fee or something or sorts. You may not have a say so in that matter.
With these considerations in mind, you need to advance into opening the account. Now there are many different providers out there- some big and some small. This is not something you typically have a choice in, though i have seen large institutions give employees the option of different companies. If you are in this situation, typically it is a matter of preference. What most people do not realize is that your employer has the power to set up the plan to his or her choosing and when multiple plans are offered they are usually comparable for the most part.
The most important part of this process is opening the account and setting up the salary deferral agreement (Selecting how much to contribute.) I have seen many people completely forget to do this, and only to realize it 5 years into their career, though many plans have began to auto-enroll you at the minimum.
Once you have enrolled in the plan, you now need to make your investment selection. You may see some of the following words and not understand what each fund does so use this as a guide:
– Mutual Fund: Think of a Mutual Fund as a big basket that holds hundreds or thousands of different shares of stocks, bonds, money markets, etc. When you buy 1 share of that fund, that fund will perform based on how all of the underlying assets perform.
– Equity: This is a fund that primarily holds stocks. Stocks are typically more risky [volatile] than other funds, but typically give you the best shot at gains. Stock = Ownership, when you buy a stock you own a small fraction of that company. The stock performs based on the financial well-being of that company and the decisions that it makes.
– Fixed Income: This is a Fund that holds Primarily holds bonds. Bonds are typically less risky [volatile] than other funds, but typically have lower returns. Bond = Debt, When you buy a bond you are buying a debt instrument. For example when XYZ Toll Road wants to build a new road, they will go out to the public and sell bonds. They would set a dollar amount on each bond [face value,] an interest rate that they are willing to pay, and a Maturity Date or due date as to when it must be paid back by. The purchaser of this bond, at the maturity date, would receive the face value plus the value of the interest.
Typically in an employer sponsored plan you are not buying the bond itself but you are buying into a mutual fund that performs based on how the bonds perform. Remember- companies CAN default on bonds, hence the risk that they have.
– Money Market or Cash Equivalent: This is NOT cash, these funds will hold government notes or other short term bonds. These funds are not risk free, but the focus of the fund is to hold the value of [$1], in other words the sole focus of the fund is typically to try to maintain the dollar value invested. You still have a chance of losing money, but you also have a small chance of a gain as well. These are meant to be very short term investments
– Index: An Index fund usually tracks something in the market. For example an S&P 500 Index Fund will seek to track the S&P 500 as best as it can. These funds typically have the lowest fees.
Whew! Okay now that you have a basic understanding of what each of those are you need to make your selection. Many plans will have a default fund, and in many cases it is a Money Market fund. MAKE SURE that if you elect the money market, you go back and change it within a timely fashion as these are meant to be short term investments. If your default is a “Lifecycle Fund,” This is a fund where you select the date closest to when you will retire. It will be more risky at first and as you approach that date it will become less risk by diversifying into bonds and such automatically. These aren’t necessarily bad funds, but they are not all created equal. They perform well at some companies, while at others they do not.
These choices (you can typically choose several funds,) will be based on your risk tolerance that we discussed earlier. Everyone is different, but typically the younger you are, the more stocks that you own. As you get older you transition to having more of a mixture of stocks and bonds. Please keep in mind, that if you are 100% stocks or 100% bonds, even though bonds are less risky, you are still taking on a great risk than you think that you are.
Most people get hung up on not knowing what to choose, the fact is NO ONE in the ENTIRE WORLD can predict what the stock or bond market will do even in the very next second. Remember we are thinking LONG TERM here, so we want to clear from our heads what is currently going on or what we think might go on in the markets [to an extent.] Remember that it is nearly impossible to time the markets. Also remember that the goal is to buy low and sell high, not the other way around, so if the market is down and you are looking into buying into some stock funds- Hey you now have a shot at getting them cheaper than what they were earlier on.
Remember – You can typically change your selections as you please [verify trading the trading frequency policy with your provider,] and therefore if you change your mind 5 years from now its okay.
Please comment below with any questions and we will try our best to answer them for you. Thanks
– The Moola Guru’s