Stashing dollars in a coffee can might build up emergency savings, but that won’t be enough to retire on. That’s because growing savings via investment is one of the most necessary aspects of saving for retirement and long-term wealth.

For many future retirees, saving money in a 401(k) plan can be an integral part of the process. But that isn’t where the value of a 401(k) plan ends; knowing how to invest one’s 401(k) portfolio can make or break those efforts to save.

Here’s what individuals need to know about investing in 401(k) plan savings, what sort of investment options are available, and what to keep in mind along the way.

How to invest in a 401(k) for retirement

A 401(k) account is an employer-sponsored retirement plan that offers tax advantages from the IRS. These accounts are generally funded with pretax dollars through automatic payroll deductions and contributions may even be matched by the employer.  

Employers choose the funds their workplace 401(k) plans can be invested in, which may include a variety of asset classes publicly traded on the stock market. This often means a combination of stocks and bonds, as well as index funds such as mutual funds or exchange-traded funds (ETFs). Employees pick from the fund(s) selected by their employer, and then invest their retirement savings accordingly. Before investing in a 401(k), though, there are a few things to consider.

How much to contribute to a 401(k)

Since 401(k) contributions are typically made through payroll deduction, employees establish their contribution rate through their employer. This means sitting down to figure out exactly how much they want to contribute over the year. Here are some questions to consider when calculating this number:

How much are you allowed to contribute?

As of 2022, employees are allowed to contribute a maximum of $20,500 per year toward their 401(k) account. That means an individual can put up to $1,708.33 into a 401(k) each month.

Do you qualify for catch-up contributions?

If the employee is over the age of 50, a catch-up contribution of $6,500 is allowed, bringing the total maximum contribution to $27,000 per year, or $2,250 per month.

Does your employer match contributions?

Many employers offer a contribution match to employees, which could be dollar-for-dollar or 50%. So if an employee puts $400 per month into their 401(k), the employer will put an additional $200 into the retirement savings plan on their behalf.

Most employer matches also have maximum limits, which are often represented as a percentage of the employee’s salary. For example, an employer might offer a 100% contribution match up to 3% of a salary, which means an employee making $100,000 could receive as much as $3,000 from their employer as long as they contributed enough to earn that full match.

Knowing how much an employer matches can help determine how much the employee needs to contribute. For instance, if the goal is to contribute a total of $6,000 into a 401(k) retirement savings plan each year—and the employer offers a 100% match—the employee only needs to budget for $3,000 in annual contributions in order to meet their goal.

How much does your budget allow you to put toward retirement?

According to recent data, the average worker contributed 9.3% of their earnings toward a workplace 401(k) account in 2021. This isn’t possible for many, so it’s important to know how much can be contributed based on factors like a household budget.

What to invest in

Determining what to invest in is an important factor when it comes to building long-term wealth and adequate savings for retirement. This means reviewing the investment funds and options offered by an employer and choosing an investment style. Here are some questions to consider:

What plans and investment products are offered by your employer?

Each workplace determines the funds and investment products that are offered to employees participating in a sponsored 401(k) plan. There may be few options or many, but it’s up to the employee to make the investment choices. That may mean researching each fund to assess its performance history, asset allocation, and fees. To that end, investors can ask the following: Are certain sectors or companies of interest? Would they prefer to stay away from specific industries? Does one fund have significantly higher fees?

What’s your risk tolerance?

Every investor can consider their risk tolerance when choosing an investment fund. This represents how aggressive, or careful, the investor wants to be with those investments; while no investment return is ever guaranteed, aggressive 401(k) investments often have a higher potential for returns compared to safer investments.

An investor with a higher risk tolerance may choose an aggressive, and therefore riskier, 401(k) strategy, like a fund that is heavy in equities such as company stocks traded on the S&P 500. A more conservative investor may opt for a plan that is heavy in mutual funds and bonds, or even one that allows for “safe” investment growth, such as money-market instruments.

What’s the time horizon?

One important factor in any investment strategy is time. An investor’s time horizon is the amount of time they need to hold onto an investment before they sell it. An investor with many decades until retirement can often afford to be a bit more aggressive with their portfolio; the longer there is between the investment’s purchase and retirement, the longer an investor has to recoup any losses and grow the investment’s gains.

Conversely, an investor with a shorter timeline may choose to be more modest with their investments. If retirement is around the corner and those funds will be needed sooner, the investor may not be able to afford a loss and the time it may take the investment to bounce back.

Some employers offer target-date funds, which are designed with a target retirement date in mind. Their investment allocations and rebalancing schedule can help investors generate income from their retirement savings while being as cautious as their timeline allows.

Do you want to be diversified?

Investors can decide whether they want to diversify their 401(k) savings and how to do it. This means spreading one’s savings efforts across a number of different types of investment, which can hedge against losses and market downturns, as other investments may grow even if certain industries or sectors see a downward trend.

The bottom line

Planning and saving for retirement can be a decades-long effort. An investor’s success can be influenced by factors such as an employer-contribution match, low 401(k) fund fees, and investment options. Many decisions go into investing one’s 401(k) savings including determining how much is needed to retire, what one can afford to save monthly, and where to invest that money.