Selecting investments in your 401(k) can be a daunting task. Many people have 401(k) plans through their employer, yet very few of them have ever received education or recommendations on how to invest within their retirement account. Although retirement accounts are a great tax saving vehicle, it is important that you take an active role in managing your 401(k) to be sure you are setting yourself up for retirement success.
Many times, 401(k)’s will offer a limited number of investment options. Some companies will offer employer stock in additional to a handful of mutual funds. Other 401(k)’s have a brokerage link option, which allows you to invest in almost any mutual fund in the market. You will have to talk with your HR department to determine your options.
Here are some dos and don’ts to help get you started:
Don’t invest in company stock
I do not recommend investing in company stock through your 401(k) (or in any other account for that matter). Why? For most people, their greatest asset is their ability to earn money. This means your greatest asset is reliant upon your company. Investing in company stock is simply putting too many eggs in the same basket. If your company fails, you will lose your job. This is bad enough without having to worry that your retirement account just lost all of its value. When in doubt, just think Enron.
Don’t select every investment option
I frequently see clients select every investment option in their 401(k). Clients will put 10% of their account into each of the 10 funds offered by the 401(k). The reason this is a bad idea is because the funds aren’t necessarily diversified. If 8 of the 10 mutual funds are 100% stock funds, then you may have way too much stock in your portfolio and not be properly diversified.
Do look at the expense ratios
Mutual funds charge an expense ratio which is effectively a management fee. Although the management fee is necessary for the mutual fund to operate, fees vary greatly between funds. Expense ratios directly lowers your returns, however you won’t see these fees come out of your account because they are deducted directly by the mutual fund. I like to see expense ratios under .4%, and even lower if possible. Stay away from the actively managed funds, as these will carry fees of 1% or even more. Remember, a 1% fee means 1% less in return for you.
Do select index funds
Most 401(k)’s these days give access to index funds. Many times these are Vanguard funds, however they can certainly be from other companies. Index funds will usually have an index such as the S&P 500 or MSCI EAFE (International stocks) in the name of the fund. These will almost always have the lowest expense ratios, so that is another way to spot an index fund. If index funds are not an option, a target dated fund may be the next best thing. I’m not the biggest fan of them, but sometimes it is the best you can do!
Do consult an investment advisor
I wish it was easy enough to invest in 401(k)’s without needing an investment advisor, but there are a lot of pitfalls you need to be wary of. Consulting an investment advisor will help ensure you are properly diversified, not only in your 401(k), but in your portfolio as a whole. Some investment advisors now charge by the hour for investment recommendations in a 401(k), so it can be a very cost effective way to be sure you are on the right path for retirement.
So what do you think? How do you currently make investment decisions in your 401(k)? Does this help clarify how to invest in your 401(k)? Feel free to share in the comments section!