What Investments Should I Use in My 401k?

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It takes more than mutual funds to create a secure retirement

I find that most people I meet are not sure how to invest in their retirement plan and they definitely don’t understand the choices being offered by their plan at work. This is why so many opt for a so called “Target date fund” that has a date near to their expected time to retire. Ah, if it were only that easy.

-What is a target date fund? Generally, it is a mutual fund that invests in other mutual funds created by the same sponsor (Fidelity, Vanguard, Merrill Lynch, etc.). The idea is that the fund manager will change the allocation to less “risky” assets as you get closer to retirement age. According to Morningstar, not all target date funds are created equal and most tend to underperform. Many owners of these funds were shocked at how much their balances declined in 2007-2009. These funds also tend to be more expensive. This is because they charge a fee and the funds they hold also charge a fee. I reviewed one recently for a client and the different layers of fees added up to nearly 3%!

So, if you don’t use a target date fund, what should you do? First, ask yourself some questions:

–Is my employer going to match my deposit? If so, how much (we like to get that employer money whenever possible) will they match?

-Am I saving money anywhere else? Having too much money in your 401k can be a problem if you need to access that money before you retire. Make sure you can take advantage of opportunities or handle emergencies if they arise. Paying taxes and penalties can really set back retirement plans.

-What is my current tax bracket (I see a lot of folks starting out who are in a low bracket so they aren’t’ getting much tax relief now and will be paying a lot more in the future)?

–Does my plan have a Roth option (that person in the low brackets should use the Roth option if available)?

See, a more important consideration than what you invest in, is how much of that money are you going to be able to spend when you withdraw the money in retirement! When you transition to retirement, diversification under the tax code is very important. We will talk about that in a future post.

Once you have looked at your tax picture; then look inside yourself. Are you comfortable with stock market ups and downs, and if so, how much? If your employer only offers stock and bond mutual funds, consider how comfortable you are during market turmoil. A lot of folks lost sleep during the big downturn in 2007-2009 watching their balances go way down and not recovering quickly. If that was you, be sure to focus on options that didn’t have a big drop during that period. You can look up the year by year performance for a fund during that time frame. This can usually be done on the website for your plan, or by going to Marketwatch.com or Morningstar for more information.

If the whole thing just seems a bit overwhelming, ask around for a referral to a financial advisor who can help you to understand the options being offered. Ask lots of questions and if you still can’t find reasonable options in your employer’s 401k, consider only contributing to the maximum that they match. Then look elsewhere to invest, where you are comfortable with the choices available. If retirement is the goal, there are many ways to get there, make sure you choose a path that works for you. If you have additional questions or just want to explore other options, contact us and we will do our best to help.
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