6 Step Blueprint for your 401k (Part 1)
So you have one of these “401k thingys” through your employer. Hopefully you have been socking money into it just like your Mom or Dad taught you. The balance has been growing these past 5 years but you still wonder if you picked the right investments that day you sat down with the enrollment paperwork with no 401k advice.
But you have this nagging feeling that you are in over your head.
Your Human Resources person won’t give you advice on whether you still have the right funds and you would ask the guy in the cubicle next to you (since he is always bragging about his investing prowess) but he is too much of a know-it-all to flatter him with your questions. It is hard to find 401k advice.
You tried calling the 1-800 number to the company where your 401k is being held – no help there either, just some confusing suggestions. Maybe you have even ventured online and googled “401k help” or “401k advice” but when the search returned over 17 million web pages you opted to check your Facebook page instead. Perhaps, you were brave enough to login to your 401k account and see if there were any tools you could use to help with all this. If you were able to work your way past all of the complicated Wall Street jargon, you might have found a tool to help you with you investment choices but in all likelihood, if you made it to the point of actually making changes to your portfolio – you left frustrated by how intimidating and confusing the interface became once it was time to pick your investments.
Rest easy my friend, you are not alone.
The sad fact is that there are literally 10s of millions of your peers and colleagues that feel the EXACT same way you do and struggle with getting 401k advice or help. They have either forgotten about their 401k altogether, and are just hoping for the best. Or their 401k still remains one of those “TO-DOs” near the bottom of their list. Thus far, most of the industry has failed to deliver 401k advice or easy to use tools for the investing public. Moreover, the 401k was created as a “DIY” retirement account for 10s of millions of savers that never asked to be DIY investors.
IF you are still insistent on managing your 401k all by your lonesome, we’ll give you 6 tips (in a two part blog series) that every 401k investor should keep in mind:
1. Favor index funds over actively managed (non-index funds): Most 401k plans have anywhere between 15-50 different options to pick from. When you are combing through all of the options available to you through your custodians on-line interface it is often impossible to understand what they are investing in based off of the fund name. If the fund options aren’t easy to understand, you can try asking your HR representative if there is a list of funds available on paper. Start by skimming for the options that have the term index as a part of their name. Write down each of these fund names separately. Why favor index funds? Simple, the expenses hidden inside them are generally a fraction of what the other non-index fund options carry. Additionally, studies have show that over time index funds outperform their non-index fund counterparts.
2. Select your Stock to Bond Ratio: Without being overly dramatic here – this will be your single most important decision you ever make with respect to your retirement account. To put it simply – history has shown that the greater the percentage of your 401k you allocate to stocks over your lifetime (without jumping in and out, trying to time the market) the better your lifetime return will be, PERIOD. The past (although no guarantee of the future) has taught us that by accepting risk (by risk I mean the periodic temporary declines in your 401k value) you have been rewarded with better returns. For those folks that cannot stomach seeing their 401ks decline in value – they are left with investing the majority of their 401k in Bonds and Stable Value investment choices. And for this, their lifetime return has been much smaller. Selecting the right stock to bond allocation will be a decision that you will need to take very seriously and spend considerable time to determine the right ratio of stocks and bonds.
3. Diversify: Once you have your list of index funds – go through them and try to select a fund in as many of these categories as possible: Large US Companies (Large Cap), Medium US Companies (Mid Cap), Small US Companies (Small Cap), Alternatives (Real Estate or Commodities), International Developed Stocks, and Emerging Markets Stocks. For the bond allocation, split your investment between US Treasury Bonds and US Corporate Bonds. One the surface these seems like a fairly easy task, but here’s the thing you need to be aware of – just because your 401k classifies it as a “Large Cap Fund” doesn’t really mean that it is, in fact, invested in Large Cap companies. Insane, isn’t it?!?! But that’s just the way it is. You are going to have to dig into the research and double-check to make sure they are really investing in the areas you need them to. By spreading your allocation out across all of these categories it will give your portfolio a better chance to earn a greater rate of return over the long run and also help reduce the volatility.
Next week we’ll finish up with the final 3 steps…stay tuned!