Get-started retirement plan
Puzzled about what to do now that you've signed up for your 401(k) plan? Our expert has some answers.
By Walter Updegrave, MONEY Magazine senior editor

NEW YORK (MONEY) -- My company matches 50 cents for every dollar I put into my 401(k). I just started this year and have a balance of about $1,200. I know nothing about investing, however. So what should I invest in to increase my account balance? --George Carter, Hickory, North Carolina

First, let me congratulate you for taking the single most important step in planning for your retirement: signing up for your 401(k) plan. Unfortunately, many people come down with a bad case of "procrastinate-itis" when given the opportunity to enroll in their employer savings plan.

That's especially true among young workers. A recent survey by Hewitt Associates found that almost 70 percent of Generation Y workers (those 18 to 25 years old) don't bother to contribute. Maybe they feel they can't afford it, maybe retirement seems like some far off concept that they don't need to worry about now, maybe they don't think about saving at all.

Whatever the reason, missing out on the chance to save through a 401(k) is a big mistake, especially when your employer is kicking in matching bucks. I mean, it's not often you have someone giving you free money.

So now that you've taken that big first step, the question becomes how do you make the most of this plan? Like many people, you've immediately turned your attention to investing. And I can certainly understand that. After all, the higher the return you earn on your contributions (and your employer's match), the larger your nest egg will be come retirement time.

Contribute first, invest later

But as important as smart investing is in building your 401(k)'s balance over the long term, before you turn your attention to that front there's something else you want to be sure you're doing-namely, contributing as much as you possibly can.

That's right, although we tend to concentrate our efforts to the investing side of the equation, the fact is when it comes to surefire ways of boosting your balance, shoveling in more money has a much bigger (and more certain) effect than savvy investing.

A study done by Putnam Investments last year illustrated this point very well. Basically, Putnam created a hypothetical "Average Joe, " who began participating in his 401(k) at age 28 in 1990, but got off on the wrong foot. He contributed very little, invested too little of his account in stock funds and he also chose funds that didn't perform very well. The study then compared how Joe would have fared over the next 25 years had he made certain moves, namely: boosting the percentage of pay that he saved, increasing his exposure to stocks and choosing better-performing funds.

The study found that while Joe certainly would have boosted his 401(k) balance by picking better funds and tilting his portfolio mix more toward stocks, the gains from those two moves didn't come close to the increase Joe would see if he dramatically boosted the amount he saved-even if he remained invested in underperforming funds. (For details on Average Joe's 401(k) adventure, check out a column I did earlier this year titled "How Even Average Joe Can Retire Rich" )

The moral: if you really want to increase your 401(k)'s balance, you should first make sure you're contributing as much as you possibly can to your account. At the very least, you want to contribute enough to take full advantage of your employer's match. But beyond that you ought to try to contribute as much as your plan allows.

Picking the right mix

Once you're saving to the max, you can then concentrate on the investing part. Here your first priority is to make sure you're divvying up your portfolio properly between stocks and bonds.

A variety of studies show that your asset allocation - the mix between stock and bonds - is what largely determines the performance of your investment portfolio. The more you have in stocks, the higher your returns are likely to be over the long term.

So why not throw the whole shebang in stock funds? Well, for one thing you can never be absolutely sure that future performance will repeat the past, so it pays to hedge your bets. And besides, the more stocks you own in your 401(k), the bigger the hit your account will take during market downturns. If you devote too much to stocks, a big loss might frighten you out of stocks completely, undermining your long-term strategy.

To arrive at a mix that's appropriate for you, you can check out our Asset Allocator. While you're at it, you should also take a look at "A Plan For Every Stage", a story that ran as part of MONEY's "Dream Retirement" cover last year and that provides specific investing and planning advice for people in several different stages of retirement.

As for specific investments in your 401(k), you're limited to the menu of funds that your employer provides. Ideally, you want to choose funds that have low costs, decent track records and a history of treating shareholders decently. I recommend you check out the MONEY 65, which is MONEY Magazine's list of recommended funds. If your employer's plan doesn't offer funds that made that list, look for funds that have similar attributes. Index funds are almost always a good bet. Their costs are typically low and since they're designed to mirror a particular market index or benchmark, you know exactly what you're getting.

Look for easy options

Or, instead of building a portfolio from the various funds in your 401(k)'s lineup you may be able to take the easy way out. Many 401(k) plans these days offer what are known as "target retirement" funds. These are as close to a no-brainer choice as you get in the investment world, which make them a great option for novices or people who simply don't want to take the time and effort to build their own portfolio.

Essentially, you choose the target fund with a date that roughly coincides with the year you plan to retire-the 2010, 2015, 2020 fund or whatever-and you get a diversified mix of stocks and bonds appropriate for your age. Even better, you don't have to fiddle with the mix as you age, since the fund automatically shifts more assets toward bonds as your retirement date nears. (For more on how these funds work, click here.)

So there you go, two nice and easy ways to grow that 401(k). Save like a demon, and invest in a diversified mix of stocks and bond funds. Do both those things year in and year out and, like Average Joe in the study, you should have a nice big nest egg that will support you comfortably throughout retirement.


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