There are lots of buzzwords that get thrown around in the world of personal finance. Some of the most common are “the economy”, “the stock market”, “401(k), and “retirement planning”. While you might know what each of these things are individually, it can be tough to understand how they all influence each other.
To help make things a little more clear, let’s take a look at how the economy affects your 401(k).
What is a 401(k)
If you’re not familiar, a 401(k) is a type of retirement account that is a sponsored by your employer. It is very similar to an Individual Retirement Account (IRA) and the main difference is that anyone can open an IRA but 401(k)s must go through your workplace.
Both of these accounts will allow you to save and invest for your future in a way that has significant tax advantages. With a 401(k), you can take money from your paycheck and have it automatically deposited into your 401(k). Usually, most employers will even “match” the contributions that you make. For example, if you deposit $100 every week your employer will also deposit $100 into your account.
There are limits to how much you you can contribute to your 401(k) account and, as of 2021, employee contributions were limited to $19,500 per year for workers under age 50 and $26,000 for those 50 and up.
So how does the economy impact your account? Let’s take a look.
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Your 401(k) is tied to stocks
When you deposit money into your 401(k) account, it is invested into a range of equities and bonds. The exact place where it is invested will depend on your employer and the type of plan that they have signed up for. For the sake of this article, it is safe to assume that your 401(k) is tied to a market index like the S&P 500.
The S&P 500 is a stock index that is comprised of the 500 most important companies in the United States. Every day, the prices of these company’s stocks is changing based on new information. How these prices change will ultimately impact the money in your retirement account.
Stock prices are constantly changing
If you ever visit google finance or watch the financial news then you know that stock prices are constantly fluctuating. Basically, whenever good news is announced stocks will usually go up and vice versa.
For example, when it was announced that the coronavirus pandemic was entering the United States, people panicked. Investors rushed to sell their stocks and get their cash because they weren’t sure what was going to happen. This caused the prices of stocks to decline and most likely resulted in a lower balance in your 401(k).
However, a year later, most of the country had been vaccinated and the coronavirus was not as big of a threat. For the most part, life had returned to normal and stock prices soared upwards. This would result in a higher balance in your 401(k).
We hope that you’ve found this article valuable when it comes to learning how the economy affects your 401(k). If you are interested in learning more, please subscribe below to get alerted of new articles as we write them!