How To Select 401k Funds

How To Select Funds In Your 401 Plan

Many employees are new to investing or just have never had time to truly get educated on investing. So, while you may be excited about saving in a 401 plan, it can be tough to know what investments in your 401 to select that fits you and your goals.

We wish investing was super simple, but there is some knowledge that can help you do whatâs right for you. If you donât have the time or prefer your investments to be managed professionally, you can choose a model portfolio which best fits your time to retirement and ârisk toleranceâ. Generally, more aggressive model portfolios will be more volatile but can provide more gains over time than less volatile, more conservative model portfolios. Picking a model portfolio can be a smart way to go, and something to consider whether you are new to investing or a sophisticated investor. FYI, some providers may offer target date funds which make it simpler to select an investment but doesnât make it simple to understand the risk you are taking.

When you diversify your investments among basic asset classes you may lower your investment risk and help increase the chances of meeting your retirement goals.

Complete Your Plan Enrollment Form

This is the form youve been waiting for! Its the one youll use to officially commit a percentage of your paycheck for retirement. But there are a couple of other things about this form you dont want to miss:

• Pre-tax or Roth: Whats the difference between a traditional pre-tax 401 and a Roth 401? A pre-tax 401 allows you to make contributions from your pay before taxes are taken out. But when you contribute to a Roth 401, your contributions are made after taxes are taken out. We always recommend the Roth option since you wont have to pay taxes on the money you withdraw from your Roth 401 in retirement. Pre-tax contributions will lower your taxable income now, but youll pay taxes on withdrawals in retirement.

Your Action Step: Contact your 401 plan manager to find out if you have the option to choose pre-tax or after-tax contributions. If you can, take advantage of the Roth option with your next paycheck!

Your Action Step: Again, your 401 plan manager can tell you if your plan offers an automatic rebalancing feature for your investment selections. Tip: call the plan manager and speak with an actual person.

Expense Ratios Are Extremely Important

Common sense tells us thatall else being equalthe less a fund manager charges the funds investors, the greater return the investors will earn.

For any given fund, the ratio of operating expenses to invested dollars stays quite consistent from year to year. Funds that had low expenses last year tend to have low expenses this year. As a result, a low expense ratio is one of the best indicators we have for predicting that a fund will show superior performance in the future.

Often, if you can find a fund thats near the bottom of the pack in terms of 1-year, 3-year, 5-year, and 10-year performance stats, youll find that the fund also has a very high expense ratio. This isnt really surprising. Its exceedingly difficult for a fund manager to overcome the year-after-year handicap imposed by high expenses.

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Check The Management Fees

Cross off all the funds that have an expense ratio higher than .2%. Hopefully you have a few of these low-cost index options.

If all of your options have fees higher than this, just narrow down the top 3 lowest fee funds available to you.I would get my company match in the 401k, and then invest in a Roth IRA instead since you dont have great investment options in your 401k.

Youll have a lot more in a separate Roth IRA.

Related: 5 Key Reasons a Roth IRA is Better Than a 401k After Getting Your Company Match

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Fund Types Offered In 401s

Mutual funds are the most common investment options offered in 401 plans, though some are starting to offer exchange-traded funds . Both mutual funds and ETFs contain a basket of securities, such as equities. Mutual funds range from conservative to aggressive, with plenty of grades in between. Funds may be described as balanced, value, or moderate. All of the major financial firms use similar wording.

Common Types Of 401k Fund Choices

Do you know what funds your 401k is invested in? You could be losing out on hundreds of thousands of dollars at retirement if it is poorly invested!

When you sign up for your 401k plan, theyll have a few different options that you can invest your money in. Its important to remember that a 401k is not an investment itself, it is an account that holds investments.You get to choose what the money in the account is invested in.

Choosing investments can be overwhelming at first! There are thousands of different funds out there to choose from. But the good thing is, your company has already significantly narrowed the choices for you .

Lets talk about the most common types of funds, and how to choose the best ones from the options available to you.

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Your 401k Plan: The Basics

A 401k is a retirement plan offered by employers that have significant tax advantages. You opt-in to the plan and contributions are deducted from your paycheck. Typically, youll elect to contribute a percentage of your yearly salary, and that percentage comes direcly out of your paycheck and goes into your 401k.

Typically, you wont be able to access the money in your 401k until age 59 and a half.

The IRS imposes contribution limits for your 401k. In 2021, you can contribute up to $19,500 per year of tax-advantaged dollars to your 401k. Those over 50 are allowed an extra $6500 catch-up contribution. Your employer match does not count toward this limit.

401k Vesting Schedules

Youll also want to become familiar with your employers 401k vesting schedule.

Being vested means that you get to keep your employers contributions to your 401k after you leave a job. It typically takes 1-5 years to be fully vested, meaning you forfeit the companys contributions if you leave your job before the vesting period is up.

Your contributions will always be 100% vested immediately, however.

Check with your HR department for specific details on your 401k plan!

401k Tax Advantages: Roth vs. Traditional

A traditional 401k is funded with pre-tax dollars, meaning you get a tax break now, but will have to pay them upon withdrawal during retirement.

If youre young, youre also probably in the lower tax bracket, so getting your taxes over with now also makes sense.

Target Retirement Funds Are Usually A Decent Choice

If your 401k offers target retirement funds as an option, theyre likely your next best bet .

Target retirement funds hold a collection of other mutual funds. They adjust your asset allocation automatically as you approach the date youve selected as your goal for retirement. That is, they move your money from more volatile/higher earning investments toward less volatile/lower earning investments as you near retirement.

Two important things to check, however, are:

The expense ratio is important because lower expense ratios tend to lead to better performance. And its important to check that the funds underlying allocation is appropriate for your own personal risk tolerance.

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What Is A 401

A 401 is a retirement plan offered by your employer that gives you the option to contribute a percentage of your salary on a tax-deferred basis. Depending on your target retirement date and financial needs, you can choose the type of investment funds within the plan that makes the most fiscal sensefrom conservative to aggressive. You can also choose how much of your paycheck to invest and how frequently you wish to contribute throughout the year. Your investments may grow over time and when you turn 59½, you may be able to withdraw these funds without penalty.

Default And Credit Risks

High-yield junk bond funds hold lower-investment-grade bonds or debt from corporations and other entities. This category of mutual funds is similar to other high-risk fund types. The underlying debt of companies held by the fund can expose the investor to default and credit risks. The low creditworthiness of the companies may expose them to bankruptcy, and they may default on their debt.

High-yield funds can perform well when economic conditions are good. However, these funds can also have periods of extreme declines, much like aggressive stock funds.

From an employer/fiduciary perspective, you don’t want to offer a high-yield bond fund to 401 participants because most of them perceive bond funds to be relatively “safe.” In a bad year, high-yield bond funds might decline in value by as much as 30%, whereas a total bond index fund would potentially decline by 5% or 10% at worst.

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Scale Up Contributions Over Time

Once you’ve picked your investments, the best thing you can do is leave your account alone and let the contributions build.

In addition to low costs and diversity, consistently investing over time i.e., every paycheck will make the biggest difference in the size of your savings. Low-cost funds are only effective if you continuously invest in them and don’t try to time the market, or pull money out when it starts to drop, a recent report from Morningstar says.

Experts also advise increasing your contributions each time you get a raise or bonus by a percentage point or two, helping you reach your goals faster.

Finally, remember that while the stock market has historically increased around 10% per year, that’s not guaranteed, and there will be periods when it falls. Experts also expect returns to be lower, around 4%, over the next decade than they have been the previous 10 years.

Still, no one knows what will happen, except that the best course of action is typically to invest in low-cost index funds consistently, over many decades. Do that, and you’ll be on the path to building real wealth.

The Difference Between An Account And An Investment

When you choose an account, you’re deciding how you want the money in the account to be treated.

For example, an IRA has certain rules about how much money you can put in every year and the kind of tax breaks you get.

A taxable account has different rulesmostly about how the money you earn in the account is taxed.

But an account isn’t what you’re actually buying. It’s just a place to hold your investments. There are many types of investmentsand thousands of mutual funds, ETFs , and individual stocks, CDs, and bonds you could considerbut choosing among your retirement investment options doesn’t have to be difficult.

In fact, investing for retirement can be as easy as figuring out when you think you might retire.

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Investing In Your 401

The variety of investments available in your 401 will depend on who your plan provider is and the choices your plan sponsor makes. Getting to know the different types of investments will help you create a portfolio that best suits your long-term financial needs.

Among the most importantand perhaps intimidatingdecisions you must make when you participate in a 401 plan is how to invest the money you’re contributing to your account. The investment portfolio you choose determines the rate at which your account has the potential to grow, and the income that you’ll be able to withdraw after you retire.

What Do Others Do

Most employer-sponsored retirement plans s, for example) use target-date funds as the “default” investment for newly enrolled participants. It’s a great option if you’re not sure what to choose.

Source: Vanguard, How America Saves 2018. This study examined employer retirement plans managed by Vanguard.

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Meeting Your Fiduciary Responsibility To Diversify 401 Investments

Before you start picking investments for your 401 plan, we recommend you first understand your fiduciary responsibility to diversify your investment menu. These requirements are outlined in ERISA section 404. Meeting them is not difficult. You just need to pick at least three core investments with materially different risk and return characteristics. A menu of equity , fixed income , and capital preservation funds can do the trick.

In short, your diversification responsibility is nothing to fear. Selecting prudent investments is where you’re much more likely to land yourself into hot water. Thats why impartial guidance is so important. In our view, you have two clear options.

Narrow It Down To The Passive Stock Funds

First things first, you need to figure out what your investment options are! This might warrant a call to HR or asking for help navigating your companys benefits site.

Once youve found your options, immediately mark off the bond funds, target date funds, and your company stock. Hopefully, they have each investment type categorized for you.

You want to find all of the stock funds available to you . It is unlikely that theyll have the stock funds divided into active and passive categories. If yours does,

This step should narrow down your choices pretty quickly!

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What Is A Retirement Fund

A retirement fund is a general term that includes a variety of different types of accounts or savings vehicles. A retirement plan sponsored by an employer includes 401s, 403s and 457s. Your diversified savings plan might also include individual retirement accounts, known as IRAs. IRAs are ideal for business owners, self-employed individuals and those who dont have employer-sponsored retirement plans available to them.

Ubiquitys Approach To 401 Investments

Since 1999, Ubiquity has worked with small business owners and financial professionals who manage their clients 401 plans. With Ubiquity, you have the freedom to craft an investment line-up that fits the needs of your small business. We also provide an unbiased approach to investments, offering a variety of flexible investment options for fund selection and management.

Whether you are looking to hand-pick an investment line up from over 20,000 mutual funds and ETFs, or choose from a variety of pre-selected turn-key investment line-ups, or optimize your 401 plans fiduciary protection with 3 Fiduciary Services, Ubiquity has you covered.

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Calculate Your Risk Tolerance

All investing is risky and returns are never guaranteed, but it can actually be more risky to keep too much of your savings in cash, thanks to inflation.

Still, you don’t want to go all in on one stock or investment, particularly if a rocky market makes you uneasy and anxious, or likely to do something drastic, like pull your money out of your account.

You’ll want to determine an appropriate asset allocation, or how much of your investments will be in stocks and how much will be in “safer” investments, like bonds. Stocks have the potential for greater returns, but can be more volatile than bonds. Bonds are more stable, but offer potentially lower returns over time.

Financial advisors often recommend using the following formula to determine your asset allocation: 110 minus your age equals the percentage of your portfolio that should be invested in equities, while the rest should be in bonds.

But think about your investing horizon. If you have decades until you’re going to retire , then you can afford a bit more risk. You might choose an 80-20 stock mix for now. When you’re older, you’ll start scaling that back, depending on your goals and, again, your appetite for risk. Experts suggest checking that your investments are properly aligned with your risk tolerance each year and rebalancing as necessary, though how often you actually do will vary based on personal preference.

Look At Average 5 10 And 15

Hopefully youve got a pretty short list of potential funds to invest your 401k in. Now, we want to fine-tune the list to find the best 2-3 funds we can.

Your company website should have the average 5, 10, and 15-year returns listed . Pick the top 3-4 funds with the highest return, prioritizing the highest returns for the longer periods. Were saving for retirement here, which means youre in it for the long haul.

One fund might have an amazing 1-year return, but then it drops significantly over the next 10 years.

You should have a pretty short list at this point.

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Contribute Enough To Max Out Your Match

Employers often match contributions you make to your own 401 plan. For example, your employer might match 50% of your contributions up to a maximum of 4% of your salary.

This is free money, but you can claim it only if you invest at least enough to max out your company’s matching funds. This is the only investment option that gives you a guaranteed 100% return on invested funds immediately with no risk, so it’s smart to always max out your match before investing in any other retirement accounts.