Your 401(k) is the first place you should look when you start investing. The account is already open, so all you have to do is fill out some paperwork to start contributing (you can ask your human resources representative how to do this). The money gets pulled from your paycheck before taxes, like magic, and you may even be eligible for some free money if your employer offers a match.
It’s one of the best and most effective ways to get started, even if you don’t have a lot of money to invest. But there’s a big question that comes up as soon as you start contributing: Which investments should you choose?
It’s confusing trying to navigate the long list of options with strange acronyms and lots of numbers next to them. So confusing that many people end up inadvertently making poor decisions.
You can do better.
In this post you’ll learn how to choose the right investments in your 401(k) so you have the best possible chance of reaching your biggest personal goals.
The Goal of Choosing Investments in Your 401(k)
Here’s one tip that will instantly make you a more sophisticated investor than almost everyone else you know: Instead of looking at your 401(k) as its own, isolated account, look at it as just one part of your overall investment plan — which includes all of your investment accounts.
That means you don’t have to perfectly or entirely match your target investment plan within your 401(k). Your real goal is to match your target investment plan once all your investments are summed up across all accounts.
Which is good news! Because your 401(k) investment options are probably limited. There are likely some good options and some not-so-good ones, and it’s unlikely that there’s a good one for each type of thing you want to invest in. For example, there may be a great U.S. stock market fund, but not a great international stock market fund.
And by viewing all your retirement accounts as one big pot, and including your spouse or partner’s retirement accounts as well, you can pick and choose the best investment options in each one so that the total across all accounts lines up with your overall plan.
Here’s how to do just that.
Step 1: Create an Overall Investment Plan
Start by laying out your overarching investment objectives:
- How much money will you sock away? Remember that your contribution rate is the most important investment decision you’ll make, so get this going before worrying about anything else.
- Which accounts will you use? Contributing to your 401(k) up to your employer match is a great start. But after that you have a number of options, and the right one depends on your specific situation. Decide which accounts you want to use and how much you’ll be contributing to each one.
- What is your target asset allocation? That is, which types of things will you be investing in (e.g., U.S. stocks, international stocks, bonds), and how much of your money will be invested in each type? (Click here to see some simple asset allocation suggestions.)
Step 2: Review the Investment Options in Your 401(k)
Ask your employer for a list of the investment options within your 401(k) and evaluate them on the following two factors:
- How does each one fit into your asset allocation? If it’s not a fit, you can ignore it. Morningstar is a good resource for looking up mutual funds to see what they invest in.
- How much do they cost? Cost is the single best predictor of future returns, so you should lean toward investments that cost less — meaning they have a lower expense ratio and fee structure.
It’s likely that your 401(k) offers a suite of target-date retirement funds, which are essentially mutual funds comprised of other mutual funds in a mix that varies based on your expected retirement date. For example, a 2050 fund (geared toward someone expecting to retire in 34 years) might be heavily invested in stock-based funds, while a 2020 fund (aimed at someone retiring in just four years) would likely hold more bond funds or other conservative investments.
Target-date funds can make things a lot easier on you, since you may only have to pick one fund and be done with it. Just make sure that any target-date fund you choose is both low-cost and a relatively close fit with your desired asset allocation – and be aware that its own allocation will shift (usually toward less risky investments) as time goes on.
Step 3: Rank Your 401(k) Investment Options
As you go through the list, you can cross off anything that either doesn’t fit into your plan or costs too much.
Then take the remaining options and rank them in general order of fit and cost. Those at the top are the investments you’re most likely to choose.
As you do this, I would consider giving strong preference to anything labeled as an index fund. That’s because low-cost index funds have been shown to outperform other investments 80% to 90% of the time.
Step 4: Work Through Your 401(k) Options in Order of Priority
First, go back to Step 1 where you decided on your asset allocation and determined how much money you wanted to put into each type of investment. You’ll need that information here.
Then, start with the 401(k) investment option you ranked as the best fit. Allocate your 401(k) money toward that investment until you’ve either used up your entire 401(k) or you’ve reached the limit for how much you want to invest in that particular thing.
For example, let’s say that you’re investing $10,000 a year across all your retirement accounts, and you want 50% of that, or $5,000, to go into the U.S. stock market.
If you have a good, low-cost, U.S. stock market fund in your 401(k), you can select to put up to $5,000 of your 401(k) contributions into that fund. (To find the total amount you’re putting into your 401(k) each year, just multiply your salary by your contribution rate: for example, $60,000 x 9% = $5,400.) If you’ll contribute less than $5,000 to your 401(k) per year, then the entire balance would go into that one fund.
If you have money left over in your 401(k) after Fund No. 1, do the same thing for Fund No. 2 in your priority list. Keep working your way down the list until you’ve used up your entire 401(k).
Step 5: Fill in Any Gaps to Your Investment Plan Using Other Accounts
If all of your retirement money is in your 401(k), then you’re done. Nice work!
If not, you can fill out the rest of your investment plan with your other retirement accounts, like your IRA.
The reason you save this step for last is that your 401(k) options are likely limited, while your IRA options are essentially unlimited. This way you make the most of the good options in your 401(k), and fill in the gaps elsewhere.
Remember to Revisit and Rebalance
As time passes and the markets move, the amount of money you have invested in each fund will rise and fall. Your 401(k) may also change its investment lineup from time to time.
So it’s a good idea to review your investments annually to rebalance and make any other necessary adjustments based on changes in your plan.
Matt Becker is a fee-only financial planner and the founder of Mom and Dad Money, where he helps new parents take control of their money so they can take care of their families. His free book, The New Family Financial Road Map, guides parents through the all most important financial decisions that come with starting a family.
Related Articles:
- A Complete Beginner’s Guide to 401(k) Plans
- Roth IRA vs 401k? You May Not Have to Choose
- What to Do With Your 401(k) When You Change Jobs
The post How to Choose Investments in Your 401(k) appeared first on The Simple Dollar.
Source The Simple Dollar The Simple Dollar http://ift.tt/1SDnlne
ليست هناك تعليقات:
إرسال تعليق