If you’re like most Americans saving for retirement, you’re probably contributing to a 401(k) account that’s either employer-sponsored or that you’ve set up through a business you own. If your 401(k) is employer-sponsored, your open enrollment period may be approaching, which means you have the opportunity to change your benefits selections if you want to.
Of course, you can choose how to invest your 401(k) savings at any point during the year. But if it’s been a while since you’ve reviewed your investments (or you don’t know what you’re invested in), open enrollment is the perfect time to review your 401(k) investments and make sure they are on the right track to help you reach your goals.
What Investment Options Are In a 401(k) Plan?
Contrary to popular belief, 401(k) plans do not offer access to the whole wide world of investment options. In fact, most 401(k) plans offer a limited number of mutual funds for participants to choose from, which range from conservative to aggressive and everything in between. Some plans are also starting to offer exchange-traded funds (ETFs), which are similar to mutual funds but are bought and traded like stocks.
For many investors with a 401(k) plan, having limited options can actually be a good thing. Inexperienced investors may get overwhelmed with too many choices, so choosing from a smaller selection is more convenient. (For those of you who want a wider selection, consider opening an IRA in addition to your 401(k). An IRA offers unlimited access to investment options.)
The investments you have available are specific to your 401(k) plan. You can find out which options are available to you by requesting the information from the financial institution that manages your company’s 401(k) plan (e.g., Vanguard, Fidelity, Charles Schwab). Common types of mutual funds offered in 401(k) plans include:
- Conservative funds that contain mostly high-quality bonds and other safe investments
- Value funds that are not overly aggressive and are typically invested in stable, undervalued companies with potential for growth
- Balanced funds that provide a mix of stocks and safe bonds
- Aggressive growth funds that carry high risk with potentially higher returns
- Specialized funds that invest in companies from a particular industry or sector
- Target-date funds that reposition periodically to become more conservative the closer you get to retirement
Again, the investment options available to you depend on the plan you belong to. Additionally, it’s possible and even recommended that you invest in more than one fund so your portfolio is properly diversified. To learn how to conduct your own 401(k) review, follow the five steps outlined below.
How to Review Your 401(k) Investments
1. (Re)Calculate Your Risk Tolerance
When beginning an investment review, it’s always a good idea to recalculate your risk tolerance. Your risk tolerance isn’t static. As you experience market ups and downs, you get a better sense of your real risk tolerance – many people realize during a market downturn that their risk tolerance is lower than what they originally thought.
Additionally, as you get closer to retirement age, your risk tolerance may begin to tend towards the conservative end of the spectrum. This is because your investments have less time to recover from market volatility. To determine your personal risk tolerance, reach out to me today for a free risk profile analysis and review.
2. Review Your Asset Allocation
Find out how your funds are allocated. Based on the funds you’re currently invested in, what percentage of your money is invested in stocks? What percentage is invested in bonds? Stocks offer the potential of higher returns in exchange for more risk, while bonds are more stable but generate lower returns.
Your age and how close you are to retirement should determine the percentages of stocks and bonds in your portfolio. For example, a 30-year-old who is 30 years away or more from retirement can afford to take on much more risk than a 60-year-old who is 5 years or less from retirement. If your asset allocation isn’t reflective of your age, it may be time to rebalance to either increase your return potential or decrease your risk exposure.
3. Review Your Portfolio Fees
Also known as expense ratios, portfolio fees are a percentage of a fund’s assets that are paid by investors for administration services, management, and advertising. You should aim for the expense ratios of your investments to be as low as possible. Portfolio fees are impossible to avoid, but a difference of even 1% in fees can significantly eat into the returns you get on your investments and thus impact your bottom line for retirement.
For example, imagine you have a retirement plan with a balance of $25,000 earning 7% in annual returns over 35 years. With a 0.5% annual fee, that balance would increase to $227,000. If that annual fee were 1.5%, you would only have $163,000 at the end of the investment period. That’s a difference of $64,000 for an investment fee that’s only increased by 1%.
A good rule of thumb is to only invest in funds with expense ratios lower than 1%. The Department of Labor requires plan sponsors (your employer) to disclose fees and charges associated with the plan so you can make informed investment decisions. If you have questions about the fees you’re paying, you should ask your employer for more information.
4. Research Funds You’re Interested In
It’s important to do a bit of research on the funds you plan to invest in. The purpose of your research is to find out:
- How the fund is allocated between stocks and bonds
- Fees associated with the fund
- The fund’s performance over time
- The companies or sectors that make up the fund.
I recommend using Morningstar to research the funds you’re looking at. Morningstar is an investment research company and will provide you with all the information listed above. Morningstar also offers a star rating (out of 5 stars) that scores the investment based on its past performance.
Although researching funds may feel overwhelming at first, I encourage you to give it a try. Take notes and make comparisons between a few different funds. With a little practice, I’m confident you’ll get the hang of it and start to recognize important information.
5. Increase Your Contribution Amount
Finally, the open enrollment period is a great opportunity to increase your contribution amount to your 401(k). If you haven’t reached the contribution limit ($19,500 per year for investors under 50 in 2021), consider increasing your contribution amount by at least 1% to 2% this year. Your future self will be glad that you did.
And if you’re not yet contributing enough to take full advantage of your employer matching contribution, you’re leaving free money on the table. If nothing else, make sure you’re contributing enough of your income to reap all the benefits of your employer match.
Call Caviness Wealth for a Free 401(k) Investment Review
At Caviness Wealth Management, we know your 401(k) plan is a huge part of your retirement plan. This makes it imperative that your 401(k) investments are working in your favor. Therefore, we’re offering free, no-obligation reviews of 401(k) investments to help investors better understand their positions. We can explain the fund(s) you’re invested in and how those investments may be impacting your progress toward your goals.
To schedule your free 401(k) investment review or risk profile analysis, click here to send me a message.
Content in this material is for general information only and is not intended to provide specific advice or recommendations for any individual.
