Sometimes, doing nothing at all can cost you. If you have cash that was automatically rolled over from your 401(k) to an IRA, for example, forgetting to invest those funds could end up being a very expensive mistake.
According to a report from the Employee Benefit Research Institute (EBRI), it's a mistake that far too many retirement savers are making. Nearly one-quarter of IRAs have what the EBRI calls "extreme allocations." These are portfolios holding less than 10% in equities. To put that in perspective, most retirement savers should be investing 50% to 80% in equities, depending on their age.
The EBRI found that many of these extreme portfolios are held in Safe Harbor IRAs. These accounts are created when 401(k) balances of less than $5,000 are automatically rolled out of the plan after an employee leaves the company. The investments are sold before the money is moved, and the new account typically holds the funds in cash or a cash equivalent.
The problem is that $5,000 in cash remains pretty stagnant. At today's interest rates, those funds are probably losing value when you account for inflation. On the other hand, if you invested that $5,000 to grow at 7% annually, you'd have nearly $29,000 after 25 years. That makes failing to invest a $24,000 mistake.
Comparison shop your retirement account options
Hopefully, you've just decided that investing your orphan 401(k) funds is the right move. The first step is to ask your Safe Harbor IRA provider about fees and investment options. Then, comparison shop. Research the IRA options with banks, credit unions, brokerages, and even mutual fund companies. If the existing provider has relatively low fees and a good selection of investment options, you can keep that account and invest from there. If not, open a new account and transfer your funds directly. You can also check with your new 401(k) plan if you have one; you may be able to move the money there.
Choose how much stock you want
Once you have the money where you want it, think about how much stock you want to hold. Stocks provide growth but also have more risk than bonds. That's a good thing. It means you can tailor the risk and reward characteristics of your account by adjusting how much you invest in stocks versus bonds.
It's best practice to hold a higher percentage of stocks when you're younger. You'd gradually reduce that percentage as you age. A 25-year-old saver might have 85% stock, but someone near retirement should be closer to 50%. This gives you growth in your early saving years, followed by stability later in life.
Start with funds
A standard IRA account may offer many more investment options than your 401(k). If this is the first time you've invested outside of a 401(k), keep your portfolio simple to start.
You can spread your money across a wide range of securities with just two mutual funds, one that invests in stocks and another that invests in bonds. Look for funds that cast a wide net and have low expense ratios. Vanguard's Total Stock Market ETF (NYSEMKT:VTI), for example, would give you exposure to more than 3,500 publicly held companies of all sizes. The fund also has a low expense ratio of 0.03%.
On the bond side, Vanguard's Total Bond Market ETF (NASDAQ:BND) is invested in nearly 10,000 intermediate-term bonds. That includes U.S. corporate and government debt, with a bit of international exposure, too. The expense ratio on this fund is 0.035%.
Or, try a target-date fund
If you want an even easier approach, look to invest in a target-date fund. You may have seen this type of fund in your 401(k). Target-date funds invest in stocks, bonds, and cash, with a composition that gets gradually more conservative as you near retirement. That means you wouldn't have to make periodic adjustments to keep your percentage of stock holdings where you want it to be. You'd only have to check in on your fund periodically and verify that it still suits your needs and risk tolerance.
If you already own a target-date fund that you like in a separate 401(k), look for the same fund or something similar in your IRA. Target-date funds are designed to be the only funds you hold in your retirement savings.
Invest that cash
Don't overlook a $5,000 balance that was rolled over automatically into an IRA after you left your last job. Five grand might not seem like much with respect to retirement savings, but it has the potential to get a lot bigger over time. Find a low-fee account that offers you some good investment options and put that money to work as soon as you can.