For many people, a 401(k) retirement plan is the biggest source of retirement savings.
Unfortunately, most people don’t use their retirement funds to the best advantage. Here are 15 ways you can get more benefit from your 401(k). And by the way, this applies to similar accounts such as the federal government’s Thrift Savings Plan. Most of these tips also apply to saving in an IRA.
• Save as early in your working life as you can. If you can manage to put $5,500 a year into an IRA for five years while you are in your 20s, that could mean an extra $1.5 million by the time you retire.
If you have a long retirement, this could give you an extra $1 million in income and add an additional $3 million to your estate.
• Save more. If you increase your savings rate by 1 percentage point every year, that will make a huge difference in the long run. You may be able to set this up so it happens automatically, and you don’t have to think about it. That would be the ideal way to accomplish this.
• Take advantage of the Roth variations of your 401(k) and IRA, especially in your early working years when you may not be in a high tax bracket. Although it’s tempting to make a tax deductible contribution, most of us spend our tax refunds on things we won’t even remember a few years later.
And I am certain that when you are retired, you will be pleased to have tax-free income from your savings.
Read: Why new tax rules make Roth accounts better than ever
• Whatever else you do, be sure that your contributions to your retirement plan are enough to get the full benefit of your company’s matching funds. After that, if you have more money to invest, what you do might depend on how good your company’s investment options are. If they leave out some important, then you can put more money into an IRA in order to fill out your investment diversification.
Read: Don’t feel ready for retirement? You’re not alone
The most important asset class to have, and one that’s missing from many retirement plans, is small-cap value.
• If you have a spouse with a 401(k), you might be able to get better options with the other plan then with your own. In this case you can regard the total of both of your savings accounts as one, and concentrate some asset classes in one account and other asset classes in the other account.
• Don’t be too conservative, especially when you are young. In your 20s in 30s and even into your early 40s, most of your investments should be in equities.
As I have noted before, every an additional 10% of your portfolio in equities adds about one half of a percentage point per year to your return. And that is a very big deal.
• Boost your returns by investing in value funds. Large cap value funds over long periods add more than 1% per year to returns, compared with the Standard& Poor’s 500 Index SPX, +0.36% . And in the case of small-cap value funds, the advantage compared with the S&P 500 is almost 4% per year.
• You can smooth out the volatility of your equity investments by adding some other asset classes. For example, real-estate investment trusts (REITs) have slightly higher historical returns than the S&P 500 — and perhaps more important — they often move contrary to the direction of the index. You will also get some important benefits by adding international large-cap blend funds, international large-cap value funds, international small-cap blend funds and international small-cap value funds. To top it off, you should consider adding a small amount of emerging markets.
My recipe for ideal equity diversification is contained in this article, which I recommend highly.
• Whenever you can, choose low-cost index funds instead of actively managed mutual funds. Studies of historical 15-year periods show that index funds usually outperform about 90% of all actively manage funds in any given asset class.
• When it comes to bond funds, choose those that invest in intermediate-term government bonds, and especially choose funds with low expenses.
• Get rid of any asset classes that don’t have a long history of beating the S&P 500. This includes gold funds, commodity funds, bitcoin, and similar things. You and your future deserve better.
• Except in a real emergency where there is no — and I repeat NO other option — do not borrow from your 401(k) plan. The real cost of doing so are awfully high, and you will almost certainly regret taking out such a loan.
• However, you might find it worthwhile to borrow money when you’re in your 20s in order to make your initial contributions to an IRA.
If you have parents who are willing to make a low interest loan for, let’s say, 10 years, you can pay that back over time. Because the money is invested from the start, you will be way ahead in your investments.
• Keep working for an extra five years before you retire. This can effectively double your retirement income. Why does it do that? For one thing, you will have fewer years that your portfolio will have to pay you in retirement. For another, you will have saved a lot more money.
Read: Delaying retirement by 6 months is equivalent to saving an additional 1% over 30 years
• If all the diversification that I recommend is more than you are willing to do, or if you just can’t do that in your retirement plan, then choose a target-date fund.
If you do that, you might also want to put some of your IRA into a small-cap value fund in order to boost your long-term returns without much additional risk.
If you do even one or two of these things, you will be a more successful retirement investor. And if you do the majority of these things, your retirement will be much more pleasant and profitable for you.
For help with making your long-term retirement plans, check out my latest podcast: “What rate of return should I use in my retirement plan?”
Richard Buck contributed to this article.