401k or index fund?

Should I invest in index funds or just increase my contribution to my 401k? Which would be a better use of my money in the long run?

Lots of “depends”, IMO

Does your company have a 401k match? If so, that’s probably your best option. Put what you need into 401k to get the maximum company match.

Does your company have good investment options in your 401k? You say “index fund or 401k?” in your title, but many 401ks have index funds as part of their investment options.

Do you think you will need this money before age 59.5? You’ll pay a penalty for withdrawing early from a 401k, though there are allowances for taking a loan against your 401k in certain circumstances.

Are you talking just a straight up investment in an index fund or a Roth IRA investment into an index fund? Both Roth and 401k give tax break benefits. The 401k lets you defer taxes until withdrawl; the Roth lets you pay taxes up front but have no taxes when you withdraw.

Do you think taxes will be net up or net down between now and when you retire?

There’s probably more questions to ask, but this is not a simple question at all. Give us some more details!

Another big item to consider (and IMHO it’s the biggest item if you’re in a high tax bracket): 401K contributions are generally pre-tax.

Let’s assume that you’re in the 50% tax bracket (I know, there isn’t a 50% tax bracket, but the math is easier this way). Let’s further assume that you find that you have a spare $100 each month after taxes that you could put into an index fund. That $100 is post-tax and represents $200 of your pre-tax income. You could put $200 a month into a 401K and have the same net effect on your post-tax situation as putting $100 a month into an index fund.

Of course, you’ll have to pay taxes on that 401K money eventually (when you start taking it out at retirement), but in the meantime it’s had all those years of compounded earnings.

(Note that I’ve not mentioned Roth IRAs in the above comments.)

My company matches up to 6%, but I’m currently contributing 10%, so I was wondering if I should be putting that extra 4% elsewhere.

Thanks GameHat and sevenwood. I guess it’s really up to me and neither is absolutely better than the other.

You might investigate putting the extra 4% in a Roth IRA, which you can then use to invest in index funds (or anything, really.) The advantage of the Roth is that it is tax-deferred – all your interest, dividends, and cap gains may sit in the account and compound until you become an old fogey and withdraw it, at which point all gains are taxed at the regular income level.

ETA: Unlike the 401k, the Roth IRA is not pre-tax, you will have taxes withheld from the extra 4% that you’re now putting in the 401k. Also, you have to set it up yourself, rather than going through an employer, but it’s pretty easy. Your friendly local financial services firm can probably do it on their website.