As I've mentioned in another thread I created a couple of months ago, I moved to another company. Part of their benefits package includes a 401k Profit Sharing Plan with American Funds. I was reading through their information booklet and advised that if I wanted to take a high volatility risk, with the percentage of my paycheck that I set aside, I should invest as follows - 70% should be in growth (mainly stocks which fluctuates the most yet has the most potential for long term increase), 20% in growth and income, 5% in bonds (doesn't fluctuate as well, but much less growth potential and more "safe"), and 5% in cash equivalents. I believe for this year, the max allowable limit is 13k a year that you could invest into 401k. Also, my company says they would match my contributions dollar for dollar up to 1 grand per year. What does this exactly mean ... that if I invest 13k a year, that would equate to 14k? What does my company get out of doing this?

If I can live with the resulting paycheck amount, are there any negatives in investing the max limit of 13k/year in 401k funds? I'm sure American Funds did their homework and research and made funds available to me that have a good chance of increasing in the long term since they won't be making money unless I make money right? They basically gave me 20 different funds to choose from (comprising the categories of growth, growth and income, bonds, etc) and it's up to me to choose how many and the percentage allocation of funds that comprise my 401k plan. I'm sure even the "worst" ones will grow somewhat over the long haul so I don't think I have to worry about choosing what - though I did try to make an educated guess based on their past performance percentage fluctuations.

Also, I keep hearing things about the Roth IRA? I take it this is a whole different thing than the 401k? Should I invest in both the 401k and the Roth IRA and what is the max limit I can invest in the IRA?

Thanks in advance.

 

SiDriver,

There are no short answers to your questions. . . But, I'll try to summarize and fill the blanks in subsequent posts. . .

1. If your company offers a 401K plan (which yours does) you should at a minimum invest such that you receive their full matching contribution. However, unless you are in a cash crunch you should aim to put the maximum allowable per year (13K or 20%). You receive the tax benefits now and depending on your age will start a nice nest egg for yourself. Its always easier to learn to live less cash in-hand when you first start working a company. . . learn, its worth it.

2. Regarding your investment mix, the typical rule of thumb is to be more risk adverse (i.e., more bond/low yeild funds) if you're older and less risk adverse (i.e., more growth/stock funds) when younger. However, I don't necessarily agree with that approach. As I learned while doing my MBA (and over my 8-plus years in the work force), diversification is key. I definitely suggest looking at more higher risk/higher return funds if you're younger, but also keep in mind what the market has been doing and adjust your percentages accordingly. Ulitimately, your investment mix SHOULD MATCH your own risk profile and return expectations, not someone elses.

3. First, before you start investing in an IRA, you SHOULD already be maxing out your 401K contributions.

That said. . . Regarding the Roth IRA question, for most people (specifically those that invest company sponsored 401K programs), the Roth IRA is better option than the traditional IRA. In both cases, your present day tax benefits will begin diminish as the amount of your 401K investment/salary increase. But, the future economic benefits of both types of IRAs (usually more so with the Roth) make investing in them worth it.

 

Thanks for the feedback Iceman. Though I've been perusing some Roth IRA sites and all of them say to invest in the 401k only up the point where your company would match your contributions and nothing more, then max out your Roth IRA contributions ($3k max limit). Why would they say invest no more than what your company can match? My company says they can match my contributions dollar for dollar up to $1k per year.

 

I don't know why those sites would say that, and I definitely don't agree with the only invest in your company's 401K up to the point where the matching contributions end.

Roth IRA contributions are done with after-tax dollars which means your taxable income is higher annually than if you invest in a 401K which use pre-tax dollars. Anytime you can lower your taxable income with investments, do it.

I've always considered my Roth IRA as a secondary investment vehicle. Since Roth IRAs are limited to a maximum contribution of $3000 for 2004, $4000 for 05' to 07', and $5000 for 2008, the idea of focusing on a Roth IRA as your primary invest option doesn't make sense to me. (unless there's something I'm overlooking)