401(k) Investing: Buy In for the Long Term

Young people can take advantage of the down market.

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Dear Planning to Retire,

As a 25-year-old watching my 401(k) balance heading in the wrong direction, should I be stuffing money in my mattress?

Having a 401(k) in your 20s already puts you on the right track. If you're a 20-something, you have the most to gain from the effect of compounding over time. But making your investment grow can be tricky, and there are plenty of pitfalls to trip you up. I posed five questions about 401(k) investing in your 20s to Brian Jones, a certified financial planner and author of Getting Started: The Financial Guide for a Younger Generation. Excerpts:

How should people in their 20s allocate their 401(k) investments?

They should be more equity based. Keep it growth oriented. I'm not a big fan of being 100 percent in [stocks], but 80 or 90 percent in equity is probably not a bad allocation. Don't worry about what the market is doing. It has absolutely no bearing on how you will be doing 40 years from now. The secret to investing is to buy low and sell high. Now is a great time to buy. What percentage of a paycheck should a 20-something aim to invest in a 401(k)?

This profession always says aim for 10 or 15 percent. Just put as much in there as you possibly can without totally crimping your social schedule. You've got 50 years. Just putting 7 or 8 percent in a year is 7 or 8 percent Mom and Dad weren't saving when they were 20. Put your pay raise into the 401(k) plan. If current market conditions are cutting into your 401(k) principal, what should you do?

If you're not retiring any time in the next 10 years, who cares? Put the money in there, and it will be all right. Mom and Dad, when they were in their 20s, didn't have a 401(k). This gives 20-somethings a huge head start over Mom and Dad. If they take advantage of this, they are going to be sitting pretty many years from now. Should young people use a Roth or a traditional 401(k)?

A traditional 401(k) [which offers you a tax deduction for contributions, subject to income limits] was the only thing out there for many years. The interesting thing about the Roth 401(k) plan is you pay the tax now and you put the cash in for 50 or 60 years, and then when the money comes out, you don't have to pay tax on it. Congress, when times are tight and I think times are getting to this point, [is] going to look for interesting ways to raise money without raising taxes. There's a lot of hope that goes into the Roth 401(k) plan that as long as Congress doesn't change the rules, a Roth 401(k) might be a better plan that a traditional 401(k) plan. But Congress has a nasty habit of changing the rules, and if they change the rules, you would be better off with the [traditional] 401(k) plan. What kind of 401(k) fees should you watch out for?

If you disagree with your 401(k) plan, there's really not a whole lot you can do about it. If a life insurance company is managing the 401(k) plan, you can rest assured you are paying more than you need to. If you're in a small company, then maybe it's possible to get the boss's ear and get it out to a competitive bid. But unless you are head of the HR division or you're the COO, odds are you can't make any changes. If you're curious about what others your age have saved, you can take a sneak peek here.