Money Mondays: More on 401(k)s

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  • As the saying goes, not so fast! Last week I talked about how many employers match your contributions to a 401(k) plan—often dollar for dollar or 50 cents on the dollar. This is free money. But it’s not the most important part of a 401(k)—it’s the dessert not the main course.

    Like I said last time, the two most important things about a 401(k) plan are 1) it is simple and automatic and 2) it is tax-deferred.  None of that changes if the plan lacks a match. So in my view, for the vast majority of Americans who have one, the 401(k) is the place to start.

    I want to flesh out why the simple and automatic is important. Say you take a new job and they have a 401(k) with no match. If you fill out the paper work, sign up to contribute 6%-8% of your before tax salary, and pick investments, it is set it and forget it.  After that you’ll be investing a little bit at a time—usually every two weeks or once per month. The pros call that dollar cost averaging, and it helps you buy more when the market is low and less when the market is high.

    On the other hand, if you don’t fill out the 401(k) paper work and think, “Instead I will do this on my own,” you are going to have to set everything up by yourself. For most people, that’s like starting a diet or redoubling their exercise. We want to do it, but often we don’t or we procrastinate.

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