This might not be our best investment option for your 401(k). Image: Flickr user _e.t.
Millions of Americans rely on 401(k) plans to help them save for retirement at work, but many 401(k) plans so many fund selections that it can be hard to figure out which ones are right for you. With limited financial education resources available to workers, many employees end up confused about how to make the right move. With that in mind, let's look at three things you should consider in selecting the best investments available in your 401(k) plan.
1. Keep it simple.
The first key to 401(k) investing is understanding that just because your 401(k) might offer dozens of different fund options, you don't have to choose all of them. Instead, it pays to be discriminating, and often, you'll find that you can get by with just one or two funds -- regardless of how many are available.
In particular, two types of investments lend themselves to a simple approach. First, target-date retirement funds give investors a tailor-made portfolio geared toward their current age and expected retirement date, automatically shifting their mix of investments from aggressive early in your career to conservative as you approach retirement. An alternative to the target-date fund is the simple asset-allocation fund, which offers a balanced investing approach in a range of different investments. Asset allocation funds don't automatically change their strategy as you approach retirement, though, so you'll have to take on that responsibility on your own.
Even if you decide to go with multiple funds, keep in mind that many funds own similar assets. For instance, you might think you have a diversified retirement portfolio if you own several different stock mutual funds. But if you look at their holdings, you might find the same positions in each -- making it much less useful for diversification than you'd think.
2. Be a cheapskate.
When it comes to 401(k) investment options, one of the biggest complaints is that they're often expensive. Especially with small employers, the companies that help set up 401(k) plans can essentially shift costs onto workers by offering only high-cost fund options.
As a worker, it's up to you to look at economizing where you can. Index funds usually have cheaper expenses than actively managed funds, and over time, most of them tend to outperform their active counterparts. Often, it's simply a case of every dollar you pay an investment professional in fees and expenses being one less dollar you have in your retirement nest egg at the end of your career. So even if your 401(k) has only one attractively inexpensive choice, take a good look at it, and if it fits your needs, don't hesitate to use it.
3. Go outside the box.
Many employers have started to realize that their employees want more flexibility in their investment options. In response, they've adopted 401(k) plans that not only offer mutual funds but also make brokerage options available to their participants. These brokerage choices can give you access to individual stocks, exchange-traded funds, and other investments that you won't typically find in most 401(k) plans.
Taking advantage of a brokerage option can let you tailor your investments to much greater detail than 401(k) plans that offer only funds. But be sure to check the fine print, because some of the brokers that help employers set up and administer 401(k) plans impose much higher fees on stock trades in worker accounts than you'd pay for a regular discount brokerage account. As long as you don't actively trade too frequently, though, even a higher-cost brokerage option can end up being preferable to a mediocre selection of funds.
401(k) plans are notorious for having lackluster choices of investments. By keeping these three rules in mind, though, you'll usually find an acceptable way to invest for your retirement.
