The Motley Fool Discussion Boards
Investing/Strategies / Retirement Investing
|Subject: Re: 401(k) and foolishness revisited||Date: 4/14/1998 5:20 PM|
|Author: TMFPixy||Number: 2823 of 78299|
Greetings, YoungNotDumb, and welcome.
<<My company is nice enough to match the first 3% of my contribution 100% and the next 3% contribution is matched 25%. If I invest 6% I get a free 3.25% from the company. You don't have to be a Fool to understand it's free money but should I invest the full 15%? or just the 6% and take my other 9% elsewhere? The 401(k) option package I received is rather vague. Striking Mutual Funds from the list leaves the following investment opportunities:
Indexed Stock Fund: All 500 stocks that make up the S&P 500.
Growth Stock Fund: Well-established, dividend paying stocks whose performance is EXPECTED to meet or exceed the S&P 500 Index.
Windsor Stock Fund: Stocks that are undervalued or out of favor.
From those three options I was thinking of 50% in the index (After reading TMF13 steps) and 50% in the Growth fund. Can anyone offer any insight or personal philosophies concerning these options?>>
Definitely contribute enough to get the maximum match because that gives you an immediate return of over 50% on your money. Beyond that amount, you're faced with the classic dilemma. What will pay you more, the tax deferral on the options within the plan or something else in a taxable account? You'll have to compare returns to do that. I've made several posts on that, but can't find them at the moment. Therefore, at the risk of boring the heck out of everybody, I'll repost the missive that describes an approach you can take to make a comparison as to what you should do. And BTW, if you stay with the 401k, the index fund is probably your best bet for the long term. The other options are managed funds, and the vast majority of those fail to match or beat an S&P index fund over the long haul.
So here's the quote. Sure will be glad when the 13 steps for this area get on line and all I have to do is paste a link.
Conventional wisdom holds that it's almost always better to invest in a tax-deferred vehicle like a 401k plan or IRA rather than in an after-tax investment. This gospel holds that even if the initial investment itself is made with money that's already been taxed, the earnings accumulate untaxed, which adds immeasurably to the positive power of compounding. Because your earnings (and often the contribution) are untaxed until you begin withdrawing money in retirement, in effect the government is providing you leverage in the investment. This boost thus allows you to amass far more money for retirement than you could in a similar taxable alternative. Additionally, you control at what rate and when it gets taxed by deciding on the amount of and when to make the withdrawal. In conventional investments, you are taxed on all money going in and on all dividends and gains in the year they are received.
All things being equal, that concept is true. Unfortunately, all things are not equal. And therein lies the dilemma. When should Fools elect to invest in a tax-deferred vehicle as opposed to a taxable alternative? That's easy. When it makes sense to do so. The trick, though, is deciding when it does. When looking at something like a 401k or 403b plan, we've already given you one clue. Use the plan at least up to the level where you obtain the maximum matching contribution from your employer. Don't turn down that FREE MONEY for the reasons we've already discussed. Beyond that level, though, or if your employer provides no match, it's a different story. Now you must look at the returns available in your plan investments as compared to those in everything else that's available outside the plan.
Let's make a simple comparison between a tax-deferred investment like a 401K plan and an ordinary taxable investment. Further, let's assume that ultimately you'll withdraw all your monies from the tax-deferred account and be taxed on that amount at today's marginal tax rates. It's not quite that simple because in reality you'll decide how that money even