When I was given information about my company's 401(k) plan, I was given an option to put a certain percentage of my income into the plan. Investing in a Roth 401(k) wasn't an option then so I only had the option to invest in a traditional 401(k) plan.
What could I afford to put into the plan? Ideally, I wanted to put 10% of my gross earnings into the plan, but could I afford to put that much into the plan? This was when I was going to put what I had learned from the book, The Wealthy Barber, into practice. 10% seemed like a lot. I was just starting out in my career, and I had expenses to pay: rent, utilities, car payments, food, entertainment. How would I be able to pay for all of these things if I automatically took out 10% of my income?
At the end, I decided to bite the bullet and elect to deposit 10% of my earnings into my 401(k) account. There are several reasons why I decided on 10%:
If I didn't do it then, then I doubted whether I would ever be able to put that much into my account,
I was committed to the idea of saving for my retirement and this was just the first step,
I wanted to start off with 10% and then eventually increase the percentage, to eventually be able to max out my contributions,
My employer did not match my contributions, so I had to put in enough to eventually reach my long term goal of having at least enough to retire, and
I wanted to learn to live below my means and having money deducted before I can even get my hands on it, will force me to live within or even below my means.
So, once I set up my account, set my contribution percentage and picked out my investments, I was set.
Today we went to the Sunnyvale farmer's market that is located at the Caltrain station by the historic Murphy Street. It's a bit sad - the farmer's market used to be on Murphy Street, but when they were doing construction on Murphy Street, he farmer's market was moved to the Caltrain parking lot and now it's going to stay. I'm sure the businesses on Murphy Street are missing the foot traffic.
The farmer's market is a great way to support local farmers. I'm not sure if I save money at a farmer's market, but I like knowing that the fruit and vegetables are fresh (or at least that is my assumption), I'm able to choose a variety of food and I can find organic produce. Also, I'm able to connect directly with the growers, chat a bit and maybe get an idea of how they grow their produce, and then I feel a bit more of a connection to my food.
I started out with $40, and by the time I was done I was left with $8.85. What did I spend my money on?
I started with a fruit stand and all of the fruits are $2/lb. They say that they grow their fruits without pesticides and in way, that is good enough for me because the fruit at this particular stand is outstanding. There is so much to choose from, white nectarines, white peaches, plums (various kinds), grapes and oranges. It's almost too much. I pick out some nice hard sweet white nectarines, and I end up with around 3.25 lbs., which comes out to $6.75.
Next, I try strawberries from 2 different stands that sell organic strawberries. I guess I insist on organic when it comes to certain fruits and vegetables, like strawberries. Generally, when a fruit or vegetable has a very thin skin, I tend to buy the one that was grown organically. Apparently, pesticides and other herbicides can easily penetrate the skin. The Daily Green blog lists the fruits and vegetables that have the highest pesticide residue and recommends buying organic when buying such fruits or vegetables. Fruits like peaches, strawberries, apples, blueberries and nectarines and vegetables such as celery, bell peppers and spinach should be organic. It's scary to think of the amount of pesticides/herbicides we consume on a daily basis and I can only wonder at the cumulative effects. I would like to organic for everything, but it's just not within my budget, so I just try to target the things that should be organic.
So, I finally decide on a stand based on a taste test. One stand had sweeter strawberries. So, for $8, I was able to get 3 baskets of strawberries. A bit pricey, but I love strawberries.
Next, I go to one of my favorite stands, the Happy Boy Farm stand. They have really good heirloom tomatoes this time of year. I was disappointed with the tomatoes the last couple of weeks, but today, they had some nice, ripe brandywine tomatoes (these are great for making tomato sauce for pasta). They are expensive - $3.50/lb, but worth it. I get around 3 lbs., and I spend another $10. A bit steep, but this can be one meal for my whole family (plus some pasta).
Next, on to the Pinnacle stand. I can buy organic produce here and they have good prices. I didn't find anything that I needed, but I generally buy carrots, broccoli and other staples here.
Since I wanted to make my pasta sauce, I was in search of a stand that generally just sells herbs. I find it and I bought some organic basil for $1.50. I also bought some purple garlic from a small stand for $1.
There's an exotic fruit stand. While $2/mango is a bit steep at least it saves me a trip to the store. Sometimes, you just have to factor in the value of your time....
Last but not least, I bought some Italian broccoli. I like this broccoli because it is tender and thus great for my little ones. I grabbed a few handfuls, and at $4/lb, it came out to $1.90.
So, for a grand total of $31.15, I was able to buy fruit for the week, enough for dinner and a side for another dinner. The fruit was a bit pricey, but I was able to get fruit that my family actually likes and is willing to eat (priceless). Sometimes the fruit at the supermarket is just tasteless, maybe they take it off the branch/vine too soon so that it ripens en route, but at a farmer's market, it seems like they allow the fruit to ripen on the branch longer.
I started contributing to my 401(k) as soon as I started my first job. It was a little daunting trying to figure out what mutual funds to invest in.
As I was just starting to invest, I wanted to look at some resources to evaluate my options, and to figure out how to allocate my investment.
Morningstar
Whenever I consider a fund, I look at the rating from Morningstar. Morningstar is an independent investment research firm that when rating funds, looks at peer data for similar funds and rates their performance against such peers. Their ratings system is very simple, they give a mutual fund between 1 star (worst) to 5 stars (best).
For instance, I currently invest in Perkins Mid Cap Value T (JMCVX)*, and Morningstar gave it 5 stars.
Expenses
What is the expense ratio for the fund? I look for expense ratios of 1% or lower, unless it is an exceptional fund. The Perkins fund actually has an expense ratio of 1.11%, which is higher than my targeted expense ratio, but it was the only good mid-cap value fund option. I like to allocate my investments across different types of funds (large-cap, mid-cap, foreign stocks and bonds), which I will discuss later.
Manager
If' I'm looking at the past returns, I am also looking at the manager. Although past returns is no guarantee of future performance, if the fund has the same manager in the past, then there is some assurance that the guiding principles for the manager will still apply and the performance for the fund will likely be consistent; however, if a new manager has taken over, then past performance has no value. The Perkins fund has two principal managers, who had been there at least since 2002.
Style Map
I look at the character of the fund, whether it primarily invests in large-cap, mid-cap, foreign companies or bonds. The Perkins fund was considered to be a mid-cap value fund, which means the managers look for mid-sized companies that have a potential for growth.
Performance
Althoughpast performance is not indicative of future performance, I generally look at the track record for as long as the manager has been with the fund. For instance, with the Perkins fund, I looked at past performance for the past year, and for the past 5 and 10 yearand since its inception since one of the managers had been there since its inception.Comparing its performance against an index fund is also informative (on the Janus site, it compares the fund to the Russell index). Since its inception, the Perkins fund had returned 11.92% since 1992, as compared to the Russell index fund, which generally returned 6.76%. Not bad.
* this is not an endorsement. This reflects my own personal investment and opinion about the fund. Please invest at your own risk.
I was reading the "Secrets of Extreme Savers" article in CNNMoney, and I was struck by the ability of these people to save so much. The main principle was to live below your means and make savings a priority.
The first family profiled, Ed Haskell and Debbie Chasteen, were able to save about 50% of their after tax income. They paid cash for everything (even their house!) I was filled with feelings of awe - they put to practice what most people give lip service to. It seems like they had a goal in mind, to have financial stability so that they can retire early and it definitely takes a lot of discipline to put into practice those goals.
When I started to look more carefully, I realized that most people seemed to live in areas where there is a lower cost of living. In the Bay Area, the cost of living is so high. One who was profiled lived in Los Altos Hills, but then I read that he was a lawyer and I was like, of course they could save so much! He probably makes so much!
I had to catch myself then and not turn into a skeptic and make excuses. It was still amazing that these people made saving priority. Of course, each of the people profiled could have spent what they made or more.
Looking more closely at their profiles, I knew that I had to start thinking about how to adopt the following principles:
separate wants from needs and really think about each purchase,
save for each purchase,
think about multiple streams of income (if possible),
have a goal in mind, whether it is early retirement or freedom,
live modestly (or reset expectations), and
prioritize.
What exactly did I want? Did I want to retire early? Did I want to stay at home with the kids? Did I want to have a large safety cushion just in case? What was my motivation? I had always been a saver, but now I was inspired to do more to ensure my goals would be met.
If your employer has a 401(k) plan, it is the easiest way to save money for retirement. It is a way to pay myself first because it is taken out of my paycheck before it is deposited into my checking out.
I think that saving for one's retirement is an important goal. Unless you are lucky enough to work for a company that has a defined benefit pension plan or are independently wealthy, you'll need to save. Hopefully, Social Security will still be around, but I have serious doubts about its solvency and I'll likely be getting very little in terms of benefits, if at all. Even then, I doubt that I could survive on Social Security alone if I'm not able to save anything, so saving something, if only a little bit is a must.
What is a 401(k)
A 401(k) plan is based on IRS code and are employer sponsored. There are two variations: (1) a traditional 401(k) account where money is taken out on a pre-tax basis and income taxes are deferred until withdrawal, and (2) a Roth 401(k) account where money is taken out on a post-tax basis, but withdrawals are tax free.
Benefits and Reasons to Invest
If you're lucky, you work for an employer that encourages 401(k) participation by matching a portion of the contributions that an employer makes. For instance, some employers will match 50% of your contributions up to 6% of your earnings, which is a 3% total contribution. This is free money! At the very least, in this scenario, one should contribute at least 6% of earning in order to maximize the employer match, but some employer contributions are subject to vesting requirements (some have a 4 year vesting period, were 25% of the employer match vests each year).
Another benefit if you invest in a tradition 401(k) is that it defers some of your federal tax liability for the current year. For instance, if you made $50,000 and contributed $5,000 to your traditional 401(k), then you'd only have to recognize $45,000 of income. This may also be a means to lower your tax bracket if you are on the fringe. However, note that withdrawals are taxed. In some sense, you only defer your tax liability but hopefully at that time, you will be in a lower tax bracket so the total tax liability will be less.
Downsides
There are a few downsides to investing in a 401(k):
Some plans offer a limit set of investment choices. I would still do a bit of research because your contributions are still an investment and it may not make much sense if you have poor choices. Before investing in any fund, I do a basic search on Morningstar and look at each fund's ratings.
Some have high fees. Look at BrightScope, to get an idea of whether your plan has higher fees than those of its peers. While it looks at outdated data, at least it will give you an idea.
It's still a bit risky. Notwithstanding the tax benefits and the ease of "investing", it's still an investment subject to risk. Note that this is a long term investment and the stock markets (assuming you invest most of your contributions in stock funds) have generally gone up in the long term, there are still risks involved. Just look at the recent stock crashes. I remember looking at my 401(k) statements in dismay last year when the stock market plunged. It felt as though all of my hard work was all for naught and that I should have just spend the money (however, if I hadn't just kept on going, I would have then missed out on the impressive rebound, but let's see how that lasts).
Withdrawals
401(k)s are supposed to be long term investments. This is supposed to be for one's retirement. Thus, the most important question, really, is when can I withdraw the funds? When I started working, I was 27 and 65 seemed like an eternity away. Was I really going to put money away now so that I can enjoy it 38 years later? In some ways, I knew that I would have to save for my eventual "retirement" but it seemed so distant, so theoretical whereas I had pressing needs that needed immediate attention. Rent/Mortgage. Food. Entertainment.
But, I knew that I wanted to take advantage of the power of compounding and start investing early. I knew that the earlier I started, the better off I'd be so I bit the bullet and started contributing to my 401(k). I have faith that in the long run, the stock market will go up, but even if it didn't, I want to at least have some money put away.
So, when will I be able to start withdrawing money from my 401(k) accounts? At the earliest, when I'm 59 and a half (59 1/2). Any withdrawal before then would be subject to an additional excise tax of 10% on top of the ordinary income taxes, unless there is a exception such as a hardship withdrawal. Hardship withdrawals include payments to cover medical expenses, cover the down payment or to avoid foreclosure on your principal residence or to cover tuition.
To avoid this, you could consider a 401(k) loan, but there are also disadvantages to this approach as well.
Contribution Limits
I believe that the maximum contribution limit for the 2009 and 2010 year is $16,500. Future limits are indexed for inflation, but may increase in increments of $500. Employees who are 50 or over are allowed to contribute more (a "catch up contribution") of up to $5,500, which can also change in the future.
Generally, I think that 401(k)s are a great investment tool to enable a person to save for the future. It is automatic (taken out before I even get my hands on it) and I get free money in the form of my employer match.
Disclaimer: this is not investment advice. This just reflects my own observations and understanding of 401(k) plans.
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