Dave Ramsey Said to Follow These 3 Steps to Pick 401(k) Investments. Is He Right?

A 401(k) is a great retirement account option for those who have access to one. Like a traditional IRA you maintain at a brokerage firm, a 401(k) comes with tax advantages. You can make contributions with pre-tax dollars and grow money tax free, although you will be taxed on withdrawals as a retiree.

If you're investing for your future in a 401(k), you need to be smart about what you do with the money you put in it. Finance expert Dave Ramsey says to follow these three steps to get the right investments for your retirement.

1. Review your plan's documents

Unlike with a brokerage account you open yourself, you have much more limited choices when it comes to your 401(k) since your employer takes care of setting up and managing this account for you. That's why Ramsey suggests starting with a careful review of your plan's documents before you move forward with starting to pick investments.

Reviewing the plan documents will help you learn the rules for how your account works and what investments are available. Ramsey is right this step is essential, since you can't make choices about what to do with your money until you know the ins and outs of the plan you're enrolled in.

You should be able to obtain these documents from HR or from your online 401(k) account. Be on the lookout for information about how your employer matches contributions, how and when you can increase your enrollment, and what kind of administrative fees (if any) you are being charged.

2. Pick the right plan

Ramsey's next piece of advice is crucial to follow. He said to pick the right kind of 401(k) to invest your money in. You may have just one choice -- a traditional 401(k) which allows you to make pre-tax contributions but requires you to pay taxes on withdrawals. But, some employers also offer another choice -- a Roth 401(k).

Roth 401(k) accounts don't provide a tax break upfront, but your tax savings comes later when you're allowed to make tax-free withdrawals as a retiree.

Ramsey is a fan of Roth 401(k)s, and those can make sense if you think you'll be in a higher tax bracket as a retiree. But the important thing is to carefully consider which of these two options makes sense for you, rather than just picking the default account.

If you do think you're paying higher taxes now than you will as a retiree, or if you would struggle to make contributions now if you can't claim an upfront deduction, a traditional account may be a better option.

3. Research different investment options

Ramsey said researching specific investment options within your 401(k) is also crucial, and he's right. Most accounts include a limited array of investment options, such as target date funds, mutual funds, or ETFs.

Target date funds are a hands-off option because you only have to pick a retirement date and your money will be invested in an appropriate mix of different assets. But they come with higher fees. Mutual funds and ETFs will require more effort from you to determine the right asset allocation, but can be less expensive.

As you're researching, you should pay attention to fees; historical performance, and risk when deciding which investments are best.

Finally, Ramsey said to select your investments once you've done the work of choosing the right kind of 401(k) and researching the different options. You can usually choose what to invest in online or by filling out a form with HR, and you will want to revisit your choices annually (unless you are in a target date fund) to make sure you're still exposed to the right risk level given your retirement timeline.

Saving for retirement is important

By taking these three steps, you can pick the right investments for your 401(k). Remember, it is up to you to take control of making sure you have enough saved for retirement. You can use the calculators at Investor.gov to see how much you need to save to hit your target goal on time and to see how much your current retirement savings is on track to produce for you. You'll have to consider likely future returns when you do these calculations, and those are based on the investments you pick.

Taking the time to research your options carefully and to find an investment mix that's appropriate for your age and risk tolerance can help to set you up for the secure future that you deserve.