According to a poll from Insider, nearly a quarter of Americans (24 percent) say they’re intimidated to invest because they don’t want to lose money. Another 41 percent say they know investing is the right thing to do to prepare for the future, but they’re nervous.
Who can blame them? Downloading a trading app or opening an investment brokerage account can be pretty intimidating. There are so many questions, symbols, charts, etc. It can leave you feeling out of your element pretty quickly!
That’s why for those people who would like to take a soft approach to the world of investing, one of the easiest ways to do it is through your employer-sponsored retirement plan – the 401k. A 401k is one of the most popular types of retirement plans offered today by most workplaces.
In this post, we’ll talk about five reasons why using your 401k could be the best way for the average person to get involved with investing and saving towards financial dependence.
1. Investment Options will be More Streamlined
Because 401k plans have been around for several years, many plans offer about the same types of investments that people can find on their own with a regular brokerage. This generally includes a small selection of mutual funds that contain everything from large-cap to small-cap companies as well as international funds. Some plans even have the simplest of offerings: index funds and target-date funds.
If your employer’s 401k plan is with a large financial institution like Fidelity or Vanguard, then you’ll most likely also enjoy the same low fees that you would otherwise pay. Whereas most or as many old-school 401k plans charge an expense ratio of 1% or so per fund, many modern plans are more competitive and may even have funds that carry no fees at all.
Some plans have expanded beyond mutual funds and also allow participants the ability to buy equities such as ETFs (exchange-traded funds) and individual stocks. As you become a more seasoned investor and want to better customize your portfolio in the future, having this ability could be extremely beneficial.
2. 401k Contributions are Automatic
One of the truly great things about 401k contributions is that they come right out of your paycheck without any interaction from you. As much as that might seem like a small thing, it has more psychological benefits than you may think.
Like it or not, people are emotional investors. That means when left to our own devices, despite our best intentions, we probably won’t contribute to our retirement plans like we’re supposed to. However, when a relatively small amount simply disappears from your paycheck (before you even realize that it’s happening), that just makes the process so much simpler.
When it comes to money, sometimes “out of sight, out of mind” is the best policy. And since you’ll never see how much was deducted unless you check your paycheck stub, it won’t even feel like anything is missing.
3. You’ll Dollar-Cost Average
In addition to seamlessly making contributions, another important benefit to participating in your 401k plan is the fact that you’ll be using a strategy called “dollar-cost averaging” without even knowing it.
Dollar-cost averaging is when you buy securities at various prices throughout the year. For instance,
- Consider a fund that went from $50 per share at the beginning of the year to $45 mid-year, and then shot up to $55 per share over a year.
- If they had waited until the end of the year to invest a fixed amount of $5,000, then they’d bought fewer shares than they would have at the beginning of the year because each share costs more.
- However, if they had spread out that $5,000 purchase throughout the year by buying shares when they were potentially lower in price, then they’d effectively have more shares by the end of the year.
Dollar-cost averaging is how so many people built wealth during the Great Recession of 2008. Though it was a scary time for investors with the markets crashing, those people who regularly contributed to their 401k plans bought shares at an extreme discount. After a few years when prices returned to normal, some of these shares were worth double what investors had paid for them during the low point of the recession.
The best part about this strategy is that you don’t have to do anything special to use it. Just keep contributing to your 401k plan and don’t change anything. With every paycheck, your contributions will naturally accumulate more shares and they will dollar-cost average over time.
4. No Taxes on Capital Gains and Dividends
In addition to 401k contributions lowering your tax bill for the year, another thing that makes it especially appealing, especially on the investor side of the equation, is that you won’t have to deal with annual taxes on your capital gains and dividends.
In a normal investment brokerage account, the investor is responsible for reporting to the IRS any capital gains o dividends that they’ve received. Although this is not incredibly complicated, it does require the additional legwork of collecting the proper documents and knowing where to report this information on your federal income taxes.
However, with 401k plans, this doesn’t have to be done. Any taxes from capital gains or dividends that you’ve received while they are in the plan may be deferred for decades into the future until you’re at least 59-1/2 years old and can start withdrawing them for retirement. That’s a lot less headache and energy that you can use to focus on other priorities.
5. Bonus Employer 401k Contributions
Finally, one of my favorite thing about 401k plans are the employer matching contributions. This is when the company you work for will offer to match every dollar you contribute up to some percentage. It might be dollar for dollar, 50 cents per dollar, or some other formula. Every plan is a little bit different.
What’s great about 401k employer matching is that it’s basically free money. Depending on how much you’re contributing and how much the company is willing to kick in, it could add a couple of extra thousand dollars to your bottom line every year. That’s more money that you’ll be able to invest, grow, and enjoy any way you see fit someday.
If you’ve signed up for a 401k or any other type of retirement plan, monitor its progress using an app like Buxfer. Buxfer collects real-time data from over 20,000 financial institutions and consolidates it into one report, so you’ll always be up to date and know how your portfolio is doing. To find out more about the Buxfer Investments feature, click here.
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