Stock jocks that many of you no doubt are, I'm sure you've grown accustomed over the years to reading (and perhaps scratching your head over) company fundamentals. Some, such as price multiples, are easily grokked. Most of us likely have a good grip on P/E, and, if you're really bucking for head-of-the-class status, maybe you've even drawn a bead on P/B (that would be price-to-book value) and P/CF (price to cash flow).
Heck, maybe you've even mastered the fine art of gauging a company's return on equity and debt-to-income ratio. If so, good for you. All of those measurements are going to come in mighty handy when you go shopping for individual stocks. They won't do you much good, however, when it comes to making one of the most -- if you'll pardon the pun -- fundamental investment decisions most of us make: which funds to pick from the lineup provided by our employers' 401(k) plans.
My Champion Funds newsletter is dedicated to helping subscribers separate the fund universe's keepers from its duds, and a free trial to that service is just a click away. Read on, though, for the inside scoop on how to get the most out of your company's 401(k) plan. I might even reveal a seriously embarrassing personal secret along the way. You just never know.
Sad truth
First, though, a sad truth: Many 401(k) plans aren't assembled by folks who know much about investing. As a result, your array of options may seem random and confused; other times, the lineups might seem narrowly restricted. And while choosing an index fund is always an easy out, many 401(k) plans -- if you can believe it -- still don't afford participants that seeming no-brainer of a choice.
Even when they do, though, I'd argue that opting exclusively for the index pick isn't necessarily the best way to go. That path will just about lead to returns that lag the market by about the amount of the fund's annual expenses.
So, what to do when your friendly neighborhood HR rep gives you 15 minutes and a form to forge your financial future? Here are three tips for finding the picks of your plan's litter.
Focus on costs increases the odds. After all, managers of funds that charge luxury-item price tags have a higher hurdle to overcome each year relative to cheaper competitors. The average expense ratio for a domestic-equity fund hovers around 1.5%. You should therefore look for funds that charge less than that, preferably much less. Indeed, many of the funds I've recommended in Champion Funds have price tags of less than 1%. Sure, that's an arbitrary number, but at least it's arbitrarily low.
Who's in charge around here?
There's nothing inherently magical about even the best-performing funds. They can only be as strong as the manager who's calling the shots. For example, Fidelity Magellan (FUND:FMAGX) -- a large-cap fund that currently counts the likes of American International Group (NYSE:AIG), Citigroup (NYSE:C), and General Electric (NYSE:GE) among its top picks -- was a veritable sure shot back when Peter Lynch was running it. Now it's a pale ghost of its former self, an asset-bloated laggard with a price tag that seems reasonable until you notice its index-hugging ways.
The point is, management matters, and it matters a lot. Despite that fact -- and in spite of the forest's worth of glossy brochures you probably received at your 401(k), ahem, "briefing" -- you may very well have a difficult time ascertaining who the man behind the curtain is. That's not an accident. Fund companies love to tout the long-term records of their best-performing funds; only rarely, however, do they market the virtues of the manager who is responsible for that record. All the better to make you think that a onetime standout is a now-and-always proposition.
That's almost never the case. Consequently, though, you may have to ask your HR rep for a little extra time to get it done. Tracking down information on the fund's current skipper, including how he's fared at other funds he's managed, is a vital step in the process of choosing the best of your plan's funds.
Intelligent asset allocation
OK, here's the embarrassing-secret portion of the show. At my first serious job, I allocated equal amounts to each of the funds in my employer's plan. That's right: As a young man with a lifetime of investing ahead of him, I was plunking down just as much in the plan's bond-fund pick as I was in each of its equity selections. And if I'm remembering correctly, there was considerable overlap among several of those. Most of 'em were of the large-cap persuasion.
After receiving some wise (in the Foolish way, of course) advice, I quickly corrected course, but the moral of my story is that you should choose your 401(k) funds in a way that's consistent with a smart asset-allocation strategy. Sure, you'll likely want to anchor your portfolio with a large-cap pick, a fund that invests, say, in the likes of Microsoft (NASDAQ:MSFT), Wal-Mart (NYSE:WMT), and Johnson & Johnson (NYSE:JNJ). But if you're lucky enough to have a plan that provides decent choices in the mid- and small-cap arenas, don't neglect them. That way, when one area of the market hits the skids, you'll have exposure to other areas that can help shore up your 401(k) portfolio.
Shannon Zimmerman, chief analyst for Motley Fool Champion Funds, is a long-standing fund fan. He doesn't own any of the securities mentioned, and you can receive a 30-day free trial subscription to his newsletter by clicking here.The Motley Fool is investors writing for investors.
