If you are not already participating in an employer-based 401K program, you should really consider doing so. It is one of the best savings/investment vehicles out there, because it invests your money before taxes are taken out. Briefly, if you are in a 401K, you choose to have a percentage of each paycheck taken out that you do not pay taxes on that is then invested in funds chosen by you (but you ARE taxed upon taking the funds out). Many times, your employer will even “match” the funds in which you invest to a certain percentage. We recommend that you invest in a Roth IRA if your employer doesn’t offer a match for your 401k, because we think it’s be better for you to be taxed now, instead of when you’re in retirement (especially if you’re fund has grown over your lifetime). But if your company has a great 401k plan with a match and you’re contributing to it, you need to have some quality knowledge when it comes to picking the right investment mix for your 401k. Here are some tips on choosing your investments:
Great… Now What?
So after you’ve enrolled, you are well on your way to saving money for your retirement (you CAN access the money earlier, but it’s not a great idea especially because there can be significant monetary penalties). But the big question still remains: what funds do you choose to put your money in? Normally, your employer will provide you with a booklet that seems like it is 1,000 pages long, full of instructions and investment advice. For most, this can be somewhat confusing and daunting.
Keep It Simple
Hopefully, we can simplify things a little for you. Do we have some hot stock tip that will give you a 50% return on your investment? Absolutely not. However, what we can do is provide you with a few ground rules that should help you make some informed investment choices. None of this is meant as binding professional advice, only some thoughts to help you with your decision.
The first thing you want to take into account is your age. Generally speaking, the younger you are the more risky you can be with your investments. The thought process is simple. If you are 20 or so, you are approximately 40 years away from retirement. If you make a bad investment choice now, it is not likely to hurt you in the least by the time you retire. However, if you’re in your late fifties, you may want to stay more on the conservative side, since you’ll be accessing the money in only a few years. Many 401k plans offer target date funds or pre-mixed plans based on how many years you have left to retire. If your target date is 2050, then you can choose a plan which is more aggressive. But if your target date is 2020, then they’ll put together a mix of more conservative mutual funds.
Read Between the Lines
Next, I will give you some quick advice on how to decipher those performance sheets that they give you with your 401k package at work. They generally have the funds broken down by their performance for the previous quarter, year-to-date, and then their return for the past year, 3 years, 5 years and 10 years. The way that I base my investment choices is to first look at the 10 year return and then the 5 year return (especially if the fund has not been around for 10 years).
Why do I choose to look more closely at these returns? Well, a 401k is a long-term investment, not a quarterly, year-to-date, or 1 year investment. So, any statistics in the short term should be discounted for the most part. These numbers are too affected by the short-term fluctuations in the markets. What you want to look at are the funds that have proven, long-term, solid growth, which can only be determined by the 5 or 10 year return.
Diversify, Diversify, Diversify
And finally, your portfolio must be diverse. Sure, you could pick the best fund out of all the choices available to you, and that could be fine, but what if something happens to that fund or it begins to perform horribly due to unforseen circumstances in the market? You have all your eggs in that one basket. You are much better off to split your money up into a variety of funds. I like to put a good bit in international funds (which are riskier), some in bonds (one of your more conservative choices) and spread the rest around in growth stock mutual funds with good 10 year track records for interest performance. Also, don’t forget you can always speak with your broker and another investment professional for some advice. Often the different funds have some descriptions in laymen terms for you, but no one expects you to all of a sudden become an investing expert and know where to invest your money.
And, I also take a look at the performance of my choices when they send out the statements (usually quarterly) and I do make adjustments from time to time.
You’re In Control
Make sure that you’re always in control of your 401k. One downside to them is that the investment options are often very limited, but again, the BIG upside is if your employer matches your contribution. It’s one of the only times you’ll EVER be given free money. Stay in control of your account. If you aren’t satisfied with the options, ask for different ones through the broker that’s offering the plan. If you leave your job, I definitely recommend taking your 401k with you. Don’t leave it at your previous employer. And remember, your plan administrator is there to help you. Don’t be afraid to pick up the phone and ask them questions about your investment choices.
Do you have particular strategy involving how you choose your funds? Please share it with our readers below.
(photo credit: urban_data)