Great news: You can retire rich with very little effort if you have access to a 401(k). The secret lies in knowing how to automate key functions within that workplace retirement account. By setting aside 20 minutes to take the three steps explained below, you can turn your 401(k) into a hands-off wealth-building machine.
1. Set your contribution rate
First, log into your 401(k) and set your contribution to 10% or more of your income. That should max out any employer matching contributions and give you a running start to a healthy nest egg.
2. Invest in target-date funds
Next, you'll choose investments. You probably have 10 or 20 funds available to you in the 401(k), but target-date funds, or TDFs, will be your low-maintenance choices. A target-date fund is a fund that holds stocks and bonds in a mix that gradually grows more conservative as you near retirement.
This evolving investment approach is a best practice for retirement savers. The idea is to seek growth when you're younger and you have time to ride out any short-term market volatility. As you age, growth takes a backseat to stability. That insulates you from watching your portfolio balance shrink by 30% just as you start taking retirement distributions.
You will recognize TDFs by their names, which always include a year and, possibly, the phrases "target-date" or "retirement." Choose the fund year that aligns with your closest expected retirement date -- this way, your TDF is on the same timeline you are.
The advantages of TDFs for the hands-off investor are:
- You don't have to rebalance your portfolio. Rebalancing is the process of resetting your asset mix to match your current risk tolerance and investment timeline. Hands-on investors will rebalance one to four times a year. If the only position in your 401(k) is a TDF, you don't have to rebalance -- ever.
- You only manage one position. Combining a TDF with other funds skews your mix of assets, possibly leaving you with more risk than you want. For that reason, if you invest in a TDF, it should be the only position in your portfolio. That's easier to oversee than a handful of funds.
- You don't have to shift your asset mix as you age. As noted, the TDF does this for you.
- The fund's "glide path" is designed by professionals. The glide path defines how the fund adjusts its mix of holdings over time. It's designed by professional investors, which is appealing if you find investing concepts like asset allocation to be overwhelming (or boring). You should review the glide path, though. Even a professionally designed investment plan must feel right before you put your money on the line. If you don't like what you see for your targeted retirement year, evaluate the funds associated with retirement years just before and after your expected retirement date.
3. Automate your contribution increases
As your last to-do, find the auto-escalation feature in your 401(k) and turn it on. This will raise your contribute rate annually according to the date and the increase you select. Time the escalation to align with the month you expect your annual raise.
Don't be scared to raise your contribution rate by 1% every year. Assuming you earn an average-sized annual raise of 3%, you can absorb a 1% higher contribution rate. That annual increase should add many thousands of dollars to your retirement account over 20 or 30 years.
Check in now and then
Once you set your starting contribution rate, select a TDF that matches your retirement timeline, and initiate annual contribution increases, your 401(k) essentially runs itself. There's not much else for you to do, other than check in occasionally. You'll want to see how your contributions are growing and confirm that your TDF is still working for you.
That's also a great time to pat yourself on the back for a job well done. Sometimes the hardest part of retirement saving is turning on the wealth-building machine and letting it run.