It’s never too early—or too late—to start saving for retirement. And saving through a 401(k) is now easier than ever, with employers increasingly enrolling new hires automatically, auto-increasing their contribution rates, and guiding them toward highly diversified default investment options.
While all this automation can be helpful, it doesn’t mean investors should simply set their plans and forget them. A 401(k) plan will be the biggest source of income in retirement for most people, so it makes sense to monitor your account on an ongoing basis. Here are five steps you can take to help ensure that you’re on track for the retirement you’re dreaming of.
1. Have a plan
Do you know when you’d like to retire? Having a goal in mind will help you plan more effectively, increasing the likelihood of your investment portfolio amounting to a healthy sum by the time you retire. If making your own asset allocation decisions sounds too taxing, a target-date fund can do the hard work for you. Target-date funds follow an investment glide path, which adjusts how the portfolio is invested over time. During the early years, when participants need exposure to growth and have a long enough investment horizon to bounce back from market volatility, the portfolios are allocated heavily to equities. As participants approach retirement and capital preservation becomes more important, the portfolio shifts toward fixed income and cash. The bottom line is that investing in a target-date fund can be a simple way to take some of the guesswork out of your portfolio’s asset allocation strategy.
2. Start early
Retirement can seem a long way down the road when starting out in the workplace, but the earlier you can start saving, the better. Not only will starting earlier allow more time to make contributions, but you’ll also be able to harness the power of compound interest. For example, imagine you have two separate investments of US$10,000 that each earn 6% a year. In one US$10,000 investment, you withdraw your investment earnings in cash each year, and the value of your investment remains the same. In the other investment, rather than withdrawing you earnings you reinvest them. If you continue to reinvest your earnings (based on our illustrative 6% return rate), after 40 years your investment will have grown by more than $92,000.¹ That’s the power of compound interest.
3. Increase contribution levels
If you were automatically enrolled in your company’s 401(k) plan, there’s a good chance that your contributions, unless changed, are set at a predetermined default rate—typically 3% of your salary. While that’s better than not saving at all, it’s unlikely to be enough to fund a financially secure retirement. Increasing your contributions on a regular basis may go a long way toward changing that. If possible, aim to set aside at least as much as your company will match, if that benefit is offered. And, if possible, try to increase your 401(k) contributions by 1% every year—some plans allow you to do so automatically.
4. Increase allocation to growth assets
Most people—especially those still decades away from retirement—can afford to increase the percentage of their 401(k) invested in stocks rather than bonds. In fact, data from John Hancock Retirement Plan Services shows just 21% of 401(k) investors who manage their own portfolio have the recommended level of equity exposure for their age group. Among those age 60 or older, this figure is even lower at just 13.9%.² Stocks have historically generated stronger investment returns than bonds over multi-year periods. When equities experience market downturns, younger investors are typically in a better position to weather volatility than those who are close to or in retirement, as positive equity market performance may help offset losses over the decades-long investing time horizon of a younger worker. This is one of the reasons why target-date funds make such a popular choice of investment for 401(k) plans. The glide path used by target-date funds allows for a heavier bias to stocks in the early years of saving, which helps maximize growth potential. As you move closer to retirement, the glide path begins to wind down the percentage of stocks in the portfolio in favor of more conservative options, such as bonds or cash.
5. Make a plan for your savings throughout retirement
As life expectancy increases, investors are increasingly at risk of outliving their savings. Some target-date funds can help counteract longevity risk by following glide paths that continue beyond the investor’s retirement date. Rather than moving almost exclusively to bonds and cash at retirement, these “through retirement” glide paths maintain a higher allocation to equities for a further decade or more, thereby potentially generating income for longer. Investors should consider how and when they’ll withdraw their savings in retirement and whether it makes sense to keep their savings working in their 401(k) plans for longer.
1. This illustration is hypothetical and is not meant to represent any specific investment or to imply any guaranteed rate of return. 2. John Hancock Retirement Plan Services JH Enterprise platform, 12/31/18. Equity exposure is calculated by taking a weighted average based upon currently invested assets for each participant. This value is then compared with the equity exposure for the appropriate target-date fund based on age to determine if the participant is below, within, or above range.