Unless you work for a retirement investment firm or a very large company, chances are your options for 401k investments are limited.
This is no accident. For many years, the reining logic among 401k plan administrators was “less is more.” They felt that too many choices would just confuse retirement savers.
Confusion leads to hesitation and, ultimately, to procrastination. Financial planners face this issue all the time. Given a choice between action and inaction on the issue of retirement, most people are like a deer in headlights.
The result, unfortunately, is that they don’t join their company plan or, worse, they do and fail to invest. They end up with the impression of saving for retirement, but their actual investments are hardly investments at all — cash accounts or nearly zero interest money market funds.
What are the best 401k investments for retirement savers? If your plan is limited, the answer might be easy, if deflating. If you have a broad choice, which is a good thing, then you have to do a bit of homework:
1. Target-date or “lifecycle” funds
These are likely to be offered in plans with limited choices. Generally, they include a year right in the name of the fund, such as “2040 plan” or similar. These funds pick a potential retirement date in the future, the number year in the name. The fund managers buy volatile, high-growth investments early on, then slowly migrate to conservative holdings as the target date nears.
Pros: Target-date funds take away the guesswork of portfolio investing and help keep you on track. It’s much less likely for you to be in a dangerously high-risk portfolio as your retirement age nears.
Cons: Often, such funds are more expensive than necessary, and their fees can demolish your performance over time.
2. Mutual funds
Common among medium-sized plans, a mutual fund selection in theory gives you better choices than you might otherwise find. In practice, however, you are limited to the 15 or 20 mutual funds the plan sells, and they might be better or worse investments than their peers in any given period of time.
Pros: Active retirement investors can fine-tune their portfolios, choosing from among several stock or bonds funds.
Cons: Mutual fund fees are much higher than the fees attached to plain vanilla index funds, and they often underperform the benchmarks.
3. Index funds
Index funds do not rely on stock picking to achieve their goal. By design, they return the market benchmark at a minimal cost.
Pros: Index funds are absolutely the best, cheapest way to track the whole market, whatever the asset class.
Cons: You’re on your own when it comes to rebalancing among asset classes, unless your plan offers a portfolio service along with index funds. It’s rare, but things are changing.
If you can find a way to use index funds or index ETFs to earn a benchmark return and rebalance periodically, your 401k plan should do fine over decades of a working life. Save enough into the plan and your retirement is well in hand.
Source: Forbes Business