If your company offers a 401(k) retirement plan as a benefit you may have questions about choosing your investment options. Everyone’s situation is unique, but unique doesn’t have to mean complicated or time-consuming.
In most company sponsored 401(k)’s your investment options are limited. Typically you have two options: creating a diversified portfolio from the mutual fund options available in your plan, or putting your money in a target date fund. Both options have benefits and drawbacks.
Target date funds
These are mutual funds which invest in other stock and bond mutual funds. The investment company determines the allocation to different funds based on targeted year for retirement. You can see the targeted retirement year in the name of the fund i.e. “Company 2040 Fund” which tells us that the targeted retirement is the year 2040. A target-date fund’s asset allocation will become more conservative as it approaches its objective target date. Since a target date fund is a diversified portfolio within itself, it is designed to hold 100% of your account balance.
- Benefits: Target date funds are usually a good option if you have limited investment experience. It is easy to do the math and figure out what year you might want to retire in, and pick the fund that has that date in the name. Since all of your money is being held in a single fund, there is no need for you to rebalance, so this is a great “set it and forget it” option. It is important to understand that target date funds do not guarantee performance and do come with similar risk to other diversified accounts.
- Drawbacks: Some target date funds are expensive. It is important to identify the expense ratio of the fund (which can be found on the fund’s information page). As a comparative data point, the average expense ratio was 0.73% across all target-date funds in 2015, according to data published by Morningstar.
Target date funds are also not the best option once you reach retirement and need to begin accessing the money. When you take distributions it is important to have the ability to choose which investments you liquidate in order to expand the longevity of your portfolio.
Creating a diversified portfolio
Most company retirement plans have a list of funds that are available; with this option you choose how to allocate your money. There should be funds that invest in different types of stocks and bonds (there may even be a few that hold both). It is important to keep two general rules in mind when creating your portfolio:
- Benefits: You get to choose your allocation and can make adjustment to your holdings. You also are able to choose how aggressive you want to be with your portfolio. If you want to learn about the basics of investing and are committed to spending time to review the investment selections, this is a great option.
- Drawbacks: You will need to do some research on your options. Your plan’s website should have an easy way to view a page with various statistics and descriptions of each investment. You will need to focus on two things:
- Investment selection—consider the following when selecting your investments: the fund’s expense ratio (cost), strategy (goal), past performance (though not a predictor of future performance, it can give you some insight on how consistent the funds’ performance has been) and risk level.
- Allocation—regardless of how far you are from retirement, have at least some (i.e. 10%) of your investments in low-risk investments such as bonds. Keep in mind you will want to move into lower-risk investments as you near retirement, and this will be something you will need to need to manage.
In the end you are responsible for preparing yourself for retirement and picking the right investments is a vital part of that process—the more time you spend learning about your options the better.
VLP Financial Advisors
8391 Old Courthouse Rd., Suite 203, Vienna, VA 22182
Belle Schneider is a Portfolio Manager at VLP Financial Advisors. She believes that strategic planning is the key to creating, protecting, and growing wealth.
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A diversified portfolio does not assure a profit or protect against loss in a declining market.
The target date of a target date fund may be a useful starting point in selecting a fund, but investors should not rely solely on the date when choosing a fund or deciding to remain invested in one. Investors should consider funds’ asset allocation over the whole life of the fund. Often target date funds invest in other mutual fund and fees may be charged by both the target date fund and the underlying mutual funds.
Belle Schneider is a Registered Representative of and offers securities and Advisory Services through Cetera Advisor Networks LLC, member FINRA/SIPC. Cetera is under separate ownership from any other named entity.