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How to Choose Investment Funds for Your 401(k)


SUMMARY: An employer-sponsored 401(k) is by far one of the most powerful tools for establishing and growing investments, no matter how much cash you have on hand. Here’s how to choose the best investment funds for your 401(k). 

An employer-sponsored 401(k) is by far one of the most powerful tools for establishing and growing investments, no matter how much cash you have on hand. But if you’re new to investing, it may seem like your employer has just handed you the keys to a space shuttle. How exactly do you drive this thing?

Although the obscure mix of names, acronyms and numbers can be daunting, there are simple strategies for choosing your 401(k) funds. 

Are you unfamiliar with what a 401(k) is or how it works? Start by reading this blog first. 

401(k) funds

Plan like the pros

Any financial professional will tell you that any investment strategy without a solid plan is an uphill battle. So where to begin?

  • Ask questions. How much risk can you tolerate? What’s your time horizon (the number of years before you plan to retire)?
  • Allocate your assets. The answers to the questions above will determine where you put your 401(k) funds, which is a process that is also known as asset allocation. Take a hard look at asset performance at least twice a year and make strategic tweaks as needed. But tweak based on your personal goals rather than in response to market fluctuations.
  • Document everything, be it on a yellow legal pad, in a Google Sheet or in a note on your phone. A basic investment policy statement may be a helpful way to pull this all together, give guidance to your 401(k) manager, and provide some stability during times of market turmoil.

Your employer likely has tools that can help you navigate this planning process.

Choose your approach

One of the key benefits of a 401(k) is that a manager has done the work of evaluating the hundreds of possible funds in the market and narrowing the list down to a select group that meet certain criteria for overall performance and fees.

Even so, there will still be a wide variety of options set before you. It’s not as simple as spinning a bottle and seeing where it points. Consider the following techniques:

One fund, on autopilot. 

If you have no taste for finance, or just don’t have the time, target-date funds may be the way to go, as they’re built for 401(k) investors. You set an estimated retirement date, and the fund moves toward more conservative investments as you edge closer to it.

One fund, with a co-pilot.

If you want the 401(k) to do most of the heavy lifting, but also allow you some flexibility, then consider target-risk mutual funds (or asset allocation funds), which keep a specific goldilocks ratio of assets, and don’t aim for a retirement date. For example, a 70/30 fund will maintain a ratio of 70 percent stocks and 30 percent bonds. The fund handles the constant rebalancing necessary to keep this mix intact.

One downside is that you’ll need to step in if your circumstances change and that asset allocation no longer fits your goals. It also won’t adjust its risk level as you approach retirement, so if you need a more conservative blend of investments, you’ll need to change the ratio or change funds.

You take the wheel

If you have a DIY spirit and want to drive the 401(k) yourself, you have free reign to pick and choose funds as you see fit. A popular way to do this is known as the three-fund approach: a U.S. total stock market index fund, a U.S. total bond market index fund, and an international total stock market index fund.

These funds have variable patterns of rise and fall between them, which together help keep your portfolio diversified. It may also be worth boosting this diversity with commodities or real estate.

Keep an eye on fees

Fees are a fact of life with 401(k) funds, even though your manager has vetted the options to minimize them. There are typically three types:

  • Investment fees. These make up the lion’s share and cover sales commissions and fees for advisors.
  • Plan administration fees. These are essentially the cost of managing your 401(k) portfolio. Someone has to pay for legal services, accounting, phone support and resources that your employer may provide on financial literacy or other related topics.
  • Individual service fees. These apply to personal features that you may use, such as rolling over your 401(k), taking out a loan or consulting a professional for additional financial advice.

Keep your eyes on the road

At first glance, the details of 401(k) funds may seem intimidating. But if you do your homework, disregard the jargon and stick to the plan (until it’s time to adjust it), the market’s long-term prospects will work in your favor.

The 401(k) expertise found at a financial cooperative like TDECU can be the GPS that helps you navigate the road to retirement. Drop us a note and let’s get started.

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