A good friend of mine who was hosting a party asked my advice on selecting two entrée items and some hors d’oeuvres based on the catering company’s offerings. No problem, I like food. What I encountered was page upon page of great sounding options. I quickly marked the items to revisit but before I knew it there were dozens up for consideration.
Paralyzed and worried how the beef wellington tenderloin compared to the mesquite roasted beef sirloin with horseradish jus, I threw up my hands and asked co-workers for advice. Too hard to decide, too many choices.
Life is full of these overly complicated yet simple decisions. Take your 401k. Conceptually it’s nice your 401k provides such a variety of investment options, but many participants don’t select what’s right for them, resulting in poor decisions and anxiety.
It’s the responsibility of the employer to set up the 401k, but it is on the employee to decide how much is withheld from their paycheck and, furthermore, how those contributions should be invested.
Ten percent should be your minimum objective, 15% would be really good. That’s the amount that should flow out of your paycheck into your 401k. In a 2018 report, the Stanford Center on Longevity determined that if you want to retire by age 65, you should be setting aside 10%-17% of your income. And that’s if you start saving as early as age 25. If you wait until 35 to start, plan on 15%-20%. People aren’t doing this, most notably younger workers, when saving has it’s greatest long-term impact.
You have funded your 401k, now what? A recent study found that the average 401k plan contained 27 different investment options, mostly mutual funds. What are the right ones to choose for your situation?
Some methods investors use are choosing funds with the best performance over the past year or selecting a fund because a neighbor recommended it, or worse yet, stay as cash, that seems safe and secure. Here’s a tip, do not do any of these.
401ks may offer a lot of variety, but you are restricted to using what’s on your plan’s list of investment options. Most 401ks will offer index type funds, typically they are Vanguard or Fidelity funds. These are low-cost index tracking funds that provide broad global exposure; if available in your plan, use them.
The stock portion should have a little more than half in a US index fund and the rest in an International index fund. For bonds, select a single index fund option that covers the US bond market. The reality is with 2-4 funds you will have excellent diversification at a very low cost, making the most of a restrictive and overly complex situation.
Another option is a “target date” fund. Here you find the year you wish to retire, then choose one of the target date funds that has a year closest to your retirement date. You do not need more than this. The fund will automatically adjust the stock to bond mix as you move toward retirement. You will pay more for this approach over the index funds, but most are within reason. But you still need to pay attention to your risk.
For instance many retirees in 2008 utilizing a target date fund thought the fund would have minimal stock exposure upon retiring. The ensuing financial meltdown left many surprised at the losses they incurred given half their wealth was still in stocks.
The real difficulty lies in keeping your emotions in check and ensuring you adjust appropriately as your goals evolve. This is particularly true the closer you get to retirement. People are unique and your personal situation may call for an entirely different allocation than what the standard formulas say.
There you have it. If you are using more than 5 funds in your 401k you are probably making your life too complicated.