You want a step-by-step guide to opening your 401(k), with screenshots, you say? No problem. As usual, the Retirist is happy to have your back if it means you’re about to invest in your future!
At the end of February, a joyous event occurred: I became eligible for my company’s 401(k) program after a waiting period of several months. I decided to capture my experience, screen by tedious screen, to show you how to set up your 401(k) and the considerations you need to make each step of the way. This was also my first time working with Charles Schwab’s interface for my own investments, since none of my previous companies had used Schwab’s services for our 401(k)s, so it was a useful “compare and contrast” opportunity to other platforms. (Ultimately, I wasn’t super impressed, but all the more reason to record this so that you can decide for yourself!)
The birth of a 401(k) on a cold February night.
My usual caveats apply here – I am not an investment advisor, no one is paying me for this, etc. – as does the caveat that even if your company does have a 401(k) though Schwab, you might easily have a different interface than I did. (This could happen if Schwab offers multiple types of 401(k) products that companies can choose from, for instance, and I have no idea if that’s the case.) Anyway, off to the races!
Step 1: Decide to do it yourself
I logged in, changed my password to something more complex than the default, and faced my first screen – do I make my own contribution and investment choices or let Schwab coax me through? Answer: self-reliance. You might say it’s because I am someone who already has done this thing and therefore doesn’t need the help, but that’s not exactly it. I tried both and found the “take advice” path to be extremely cumbersome, with fields that were tough to change in places where I knew I needed something different than what Schwab was telling me based on my personal circumstances. Besides, if you learn how to self-direct your enrollment now, you’ll know forevermore, and won’t that be a great skill to have? #teachawomantofish
Step 2: Say how much money you’re laying down
The next screen gave me the chance to do two important things: choose how much of my money I wanted to allocate to my Schwab retirement account and choose whether I wanted that to go into a standard 401(k) or a Roth account.
On the first point – how much to contribute? – the thing I left out of this screenshot was a set of calculators Schwab offers on the right sidebar. One of those allows you to see how your contributions to this account will reduce your take-home pay on a monthly basis. Remember, it’s not a straight trade of $1 contributed = $1 reduced pay – because these are pre-tax dollars that you’re contributing. They are more valuable than the dollars that hit your bank account, which are post-tax dollars. The calculator can therefore be useful if you’re on a budget and/or want an easy way to understand, based on your tax rate, how much your take-home pay will be affected.
But seriously, how much should you contribute? There is no real easy answer here (or else a universal retirement calculator would exist), but there are a few things to consider. The first, don’t contribute so much that you might need to withdraw this money to make ends meet. The penalty for most early withdrawals is 10%, a huge hit compared to your likely annual earnings of 5% or so, and this means it’s never really worth it to withdraw unless you no other options. The second consideration: $18,000 is the maximum annual 401(k) contribution amount for most savers, so don’t go over that. Everything in the middle is a bit more subjective. Are you trying to pay off costly, high-interest debt and so should throw your excess money there, contributing relatively little to retirement? Are you also contributing to a Roth IRA account (with a $5,500 annual limit)? Are you in pretty decent shape financially and ready to commit whole hog to your future with your 401(k)?
Ultimately, my answer is to contribute as much as possible, call it something like 10% or 12%, and at least 7%, for 20s without major financial burdens. To be clear, this is a massive generalization based on my past experiences with my and others’ retirement savings, but start playing with these guidelines and Schwab’s calculators and you will hopefully see that you can contribute more than you had thought you could. Remember, money invested when you’re young is more valuable than money invested when you’re older, so put those dollars to work today and reap greater benefits later.
On the topic of the Roth contribution, know that a traditional Roth is taxed and considered by the government differently than the 401(k) in a few ways. What you need to know for now is that the annual limit for traditional Roths and Roth IRAs is $5,500 combined (across both accounts) depending on your income. The Roth IRA is more tax advantaged than the 401(k) or traditional Roth, meaning if you can, I would say to open a separate Roth IRA (you don’t do this through your employer or this screen; go somewhere like Vanguard) and put all $5,500 in there and the rest in your 401(k). If your income as a single filer is significantly higher than $113,000, you may be ineligible for the Roth IRA and should therefore explore how much you can put in your Roth versus 401(k).
Let’s recap: So you’ve invested 13% of your income in your 401(k), great! Time to take the next step towards asset allocation.
Step 3: Brief interlude – bypass Schwab’s pointless window
Check out the above and do not check the box. If you do, it’s a pain point with this interface that you’ll need to account for more options than you have in your account, very wonky, not fun or necessary to your setup. Instead, hit “continue” and breath freely.
Step 4: Choose higher risk and lower fees.
I was at this stage faced with myriad options, and I want to warn new investors not to quail at this pass. This is your time to undertake asset allocation for your 401(k), and it can be as simple or complex as you want.
Let’s go with simple: When you open a 401(k), you open a tax advantaged way to invest in stocks, bonds, etc. for your retirement. Your company has a limited number of offerings for you – call it a mix of a dozen funds, some of which are heavily weighted towards different types of stocks or bonds or other things. (Funds diversify your exposure to investments of a certain type, so a stock-type fund would be composed of many different stocks. That means if one company’s stock goes down, the fund is not completely high and dry.) In my case, you can see Schwab organizes these funds by their focus type, such as the stocks of large companies or stocks in international markets. I haven’t shown all of the options my company gives, but there isn’t much more to this list besides bonds.
Many people who are new to this process feel overwhelmed by the process of picking investments. Don’t fret; there are a handful of simple guidelines that will get you through this.
First, as a 20-something, you should generally go high risk, high reward, because you have years in the market to absorb that risk and reap that reward. Your assets should be about 90% stocks and 10% bonds, so if you just want to pick two things, put 90% of your 401(k) contributions in a standard, large company–oriented stock fund and 10% in almost any bond fund. If you want to get a bit more granular, do about 80% in large company stocks, 10% in international stock markets, and 10% bonds. If you want to read more on the reasoning here instead of just listening to me, I suggest you read this awesome, in-depth exploration of asset allocation by the Financial Samurai.
Second, remember that you don’t need to touch this for about 10 years – in fact, no need to look at it more than every six months or even annually. Only when your life circumstances change big time (age, possible homeownership, etc.) should you start reviewing your investments and whether and how to adjust down your risk. So in other words, relax.
Third, I generally advocate for going low fee. As an investor, you’re charged for each fund you invest in, and the charge comes in the form of an expense ratio. This is a cost calculated as a percentage of the money you have in the fund. Fund management is a service, so like any service, you would pay more for some fund managers than others, right? My answer is “meh.” You should pay more for a fund that you believe will garner greater returns. However, beating the stock market is, in a word, tough. How do you, a regular ol’ investor who doesn’t spend all day becoming a stock genius, know whether a fund is likely to beat the market? I sure don’t, and I don’t want to waste my money on a gamble I don’t understand the stakes of. I therefore go in for low cost funds that track the market. That way, you’re not paying out big fees for some vague management services, and you are likely to have returns because you are tracking the market, which has always gone up over time. (This is a simplified version of the Jack Bogle investing method that led to the formation of Vanguard.)
You’ll have to click in to each fund to see how much you’re paying, and one rule of thumb is that anything with an expense ratio of 0.5% or under is probably fine. This leads us to…
90% of money in low cost stocks + 10% in low cost bonds = you are in business, my friend
Step 5: Let your 401(k) work for you
You are so close! You are rounding the finish line – do not let some line about capital preservation stand in your way. When you scroll to the bottom of the asset allocation page in this 401(k) enrollment, you see a “Total” field that double-checks that you’ve allocated all your money (100%) across different investments. Then you’re asked to choose how often you want to rebalance. Rebalancing happens in the event that there is a skew in your investment outcomes such that your money is no longer allocated in the percentages you chose. To illustrate the concept, if your bonds somehow shoot up and stocks tank, you could find yourself with 25% in bonds and 75% in stocks, an allocation you don’t want to keep really when the market rights itself. Rebalancing means Schwab takes a periodic look to make sure your asset allocation strategy remains the same by moving money back towards these percentages you’ve chosen. You can rebalance “semiannually” or “annually,” not too much of a difference since you’re not touching this for a while.
What are those other warnings below? Take a look if you’d like, but basically they discourage short-term trading. You don’t care about that because short-term trading is a non starter for your 401(k) account, and “set it and forget it for 10 years or a life event” is your motto instead.
Step 6: Success is at hand – you’re an investor!
Look at you, successfully investing your money. Take a moment to confirm that the contribution rates and adjustments are what you want them to be, and then congratulation yourself. You are now the proud owner of a brand new 401(k)!