Setting a near term goal for a 401(k) or IRA will assist in assessing investment choices and monitoring progress toward a specified goal.

Photo by Carolyn Forsyth

August, 2017

Managing a 401(k)

To many individuals, selecting a mutual fund or funds for their 401(k) constitutes management. They select a fund, they moan when the fund doesn’t perform to their liking and they smile when the fund is doing well. That’s passive investment, at best, and the results of such an approach are unpredictable.

In order to manage your investment dollars, you need to set a goal and you need to monitor your progress. That doesn’t require daily checking of the fund but it does mean having some interest in the overall world and understanding that the financial markets will react to events and that these reactions will be reflected in some of your investments.

Set a Goal

The major issue with retirement planning (which is the ultimate focus of a 401(k)) is that retirement conjures up a nebulous date related to age.  That age, for at least half the working people out there, is more than 20 years away (which gives them a lot of time to save but also makes it a goal that has little meaning). An individual with a 401(k) receives a quarterly statement, sees that the dollar amount in their account has gone up and waits 3 more months for the next statement. Age and dollar amounts don't correlate.

To make your 401(k) meaningful set dollar goals in shorter time frames to which you can relate.

Because 401(k)s are fed with regular contributions and company contributions add a bit more, the balance is likely to move upward just because of the contributions. The additional growth will come from the investment choice you have made.

Consider the plan below:

The current 401(k) has a balance of $20,000. The goal is to increase the 401(k) to $50,000 in 5 years. During the first year, the contributions to the 401(k) will be $3,900 (the payroll contribution and company contribution combined). By the end of Year 1, the plan envisions a mutual fund return of $1,091. This requires a return of 4.90% which is very conservative for the first year. If the returns are higher, the plan is ahead of schedule. If the returns are lower, it would be good to reexamine the investment choices and you have time for the investment returns to recover.

The overall plan utilizes an Average Return Rate of 6.98%.  But the rate is changed each year. This allows the plan to account for ups and downs in the market place.  In any one year, expecting a return of 10% in a 401(k) would be considered aggressive. But expecting a return of 10% in a 401(k) over 5 years would not be considered aggressive. Because this plan is relatively short (compared to retirement) it is appropriate to be conservative in the choice of return rates. The annual return rates utilized are:

Year 1   4.90%

Year 2   6.00%

Year 3   7.00%

Year 4   8.00%

Year 5   9.00%

When we apply these rates to the plan we can see how contributions and returns contribute to growth.