UNDERSTANDING THE BASICS :
WHAT IS A 401 ( K )?
According to the U . S . Internal Revenue Service but in simpler terms , a 401 ( k ) is a retirement savings plan sponsored by an employer . It allows you to contribute a portion of your pre-tax salary into various types of investments like stocks , bonds and mutual funds . In most cases , you won ' t pay taxes on the money until you withdraw it during retirement , allowing your investments to grow tax-deferred ( i . e . postponing tax payments ) over time .
THERE ARE TWO MAIN BENEFITS TO PARTICIPATING IN A 401 ( K ) PLAN :
TAX ADVANTAGES : Your contributions are made with pre-tax dollars , reducing your taxable income for the year . This can be particularly beneficial for first responders who might be in higher tax brackets due to overtime , hazard pay or second jobs .
EMPLOYER MATCHES : Many employers offer to match your 401 ( k ) contributions up to a certain percentage . This is essentially free money that can accelerate the growth of your retirement savings .
SETTING UP YOUR 401 ( K ) PORTFOLIO
Think of your 401 ( k ) not just as a retirement account , but as a versatile financial toolbox filled with various investment options . Choose these investment tools carefully to match two primary considerations :
RISK TOLERANCE : Over time , the value of your 401 ( k ) investments could drop . Figure out what level of loss you can tolerate . If you can handle big losses from time to time , you are in the high risk-tolerance category . If you have no stomach for losses , you have a low risk tolerance . First responders often face financial uncertainties like job-related injuries or early retirement , which can significantly change their risk tolerance over time .
TIME HORIZON : This is the amount of time you have until you plan to retire and start withdrawing from your 401 ( k ). The longer your time horizon , the more risk you might be able to take on since you have more time to recover from market downturns .
Once you ' ve assessed your risk tolerance and time horizon , the next step is to decide on your asset allocation . In other words , how you divide your portfolio among stocks , bonds and cash . Each type of asset comes with its own set of risks and rewards .
STOCKS : Offer the potential for long-term growth , but come with increased volatility and risk .
BONDS : Provide regular income and are generally less volatile than stocks , but offer lower growth potential .
CASH : Can be easily accessed and preserves capital , but offers very little growth .
If you ' re unsure how to assess your risk tolerance and time horizon to determine the right asset allocation , don ' t worry , you have numerous options for how to proceed .
INVESTMENT QUESTIONNAIRE :
Asset managers like Vanguard offer questionnaires that can guide you toward an appropriate asset allocation based on your answers .
CHECK OUT THIS INVESTOR CALCULATOR
CONSULT A CFP : A fee-only Certified Financial Planner can provide tailored advice based on your individual financial situation and goals . Never be reluctant about asking any financial planner about how they make their money .
TARGET-DATE FUNDS : These funds automate investment selection and portfolio management for you based on your intended retirement year . As you near retirement , the fund automatically shifts toward more conservative investments as we tend to become more fiscally cautious as we age .
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