The Simplest Guide to a 401K Part 1

One very important vehicle of investing that people can use is the 401k. But what exactly is it? How does it work?

A 401k is an employer sponsored retirement program. The name for it comes from the section in the U.S. Internal Revenue Code. Employees contribute a portion of their income (taken from their paychecks) pre-tax. Pre-tax means that you will not be taxed for it until you withdraw it.

The actual work of administration and monotoring the retirement accounts is done by an independent bank, mutual fund company, financial service and more. The types of investments that are offered are stocks, bonds, money market instruments, and my personal favorite-mutual funds.

So why should we invest money in a 401k? Companies are moving away from pensions and into 401ks. If you are looking into starting investing long term, they are a great place to start. The most important reason would be if a matching contribution is involved. That is free money! For example, my current employer offers a match of up to the first 3% of my income. Therefore, if I invest a minimum of 3%, the company will match 3% every time as well. It’s free money so take advantage of it.

When investing in a 401k one should study and understand the risks involved with investing. Most financial experts would suggest to have a well diversified portofolio to help minimize risk. As with any long term investing, this is not ment to make you rich overnight. This is ment to grow steady and slowly with compound interest working its magic.

In Part 2, I will talk about the details in a 401K.

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