Investing for retirement is important, and 401(k)s offer some of the best benefits to entice workers to prioritize contributions. But what happens when your employer plan doesn’t give you the investment choices you want?
That’s something Stephen M. has been grappling with. He sent this email:
Have you done an article talking about how to invest within work 401(k) and matches, mainly how to navigate and research the existing funds in the plan, and create the best diversified portfolio for situation you can with contained options ?
It’s worse than any other investing of course because no matter where I’ve worked it’s been locked to some 20 funds, and nearly all of them will have 1.0 percent expense ratios and be overall just not what I’d pick if I had my choosing. Also some work places would match in company stock instead of actual share bought from one’s investment elections 😵.
I was helping a friend with her finances, and a lot of these workplace 401(k)s will have a default signup that will start at two to four percent and sign up to increase one percent a year, regardless of the match percent work gives.
On top of that, it also signed her up for a actively managed target date plan offered that had a much higher expense ratio than the other index offerings within the plan.
In her case, since she had high int. credit card debt, I found that her one percent a year increase had brought her to six percent when her work only matched up to four percent. It obviously made sense in this case to move it down to four percent at the match level and use the extra two percent to pay off the credit card debt/increase cash flow.
How to maximize your 401(k)
You’ve pinpointed one of the most common complaints about workplace 401(k)s, that they have limited options that can be, depending on where you work and who your fund manager is, quite pricey. If you’re dissatisfied with what you’re offered—and you’ve done the work to discover that your expense ratios are high—then it makes sense to contribute up to the employer match and then branch out.
Typically, I’d say contribute up to the employer match and then look to a traditional or Roth IRA. But if your friend does have a lot of debt (likely with an interest rate at 17 percent or higher), paying that down first makes a lot more sense. As she pays down her debt, she can look to her other investing options. If you’re interested in learning more about this reasoning, I laid out the order in which I’d prioritize financial goals.
As to your first question, there are plenty of tools out there that will analyze the funds offered by your company. One easy way: search a fund’s ticker symbol on Yahoo Finance or Morningstar, and you’ll get a breakdown of the companies included. You can also research the fund on its company’s website. So, for example, if you’re offered the FUSEX, or Fidelity 500 Index Investor, plug it in to Fidelity’s website and it will tell you what you need to know.
Another commonly recommended site is Brightscope which lets you research and analyze your funds. Alternatively, you could search the fund name + prospectus, and you’ll get a breakdown of the holdings. Your account statement should also list the funds you’re invested in. Another option: See what magazines like Kiplinger recommend each year, and compare with what your employer is offering.
To target date, or not to target date
I’ve written about the downsides of target-date funds before, which you’ve also noted—the potentially higher expense ratio. A target date isn’t the worst option in the world, especially for newbie investors, but if there are other comparable index options offered more cheaply, then it makes sense to go with those. Personally, I’ve found the target dates I’ve been offered to be too conservative, but that will depend on your risk tolerance. Just note that choosing your own funds means you’ll be responsible for rebalancing and tracking expense ratios and performance for every fund, etc., which target dates do automatically.
As far as diversification, a broad market index fund or two should do the trick. You might encourage your friend to try a three-fund portfolio, or at least have a mix of domestic stock, international stock (this can sometimes be combined to a “total world” stock fund) and bonds. You can use this asset allocation calculator if you’re unsure of what to do.
If your plan doesn’t offer funds like that, then you’ll have to do your best to approximate it. As Lifehacker covered previously, you could combine:
An S&P 500 fund (which includes 500 of the largest companies in the US)
A mid-cap index fund (which includes medium-sized companies, making up for the medium-sized companies missing from the S&P 500)
A small-cap index fund (which includes smaller companies, making up for the small companies missing from the S&P 500)
Your 401(k) should offer you at least those options. If it doesn’t, remember you can contribute up to the employer match and then open an account elsewhere. Here’s how that might shake out:
Contribute only enough in 401k to take advantage of employer match.
Contribute any additional savings to an IRA, which has more flexibility.
If you still have money after maxing out your IRA (you can see the limits
here
), then go ahead and put it in your 401k.
If you max out both your 401k and your IRA (wow, good for you), you can open a regular taxable investment account. These accounts are also good for more medium-term goals, since retirement accounts don’t let you withdraw until later in life.
Invest in the cheapest (quality) funds your 401(k) offers, and then get that broad diversification in your IRA.
If you’re really unhappy with your 401(k) options, it’s worth bringing up with management or your benefits department. They might not take action, but you could find you’re not the only employee to take issue with what’s offered (and if you’re part of a union, that’s something to bring up to your representatives). If you’re married and your spouse has a better retirement plan than you do, consider diverting more of your assets to theirs.
Finally, don’t forget that your 401(k) offers tax benefits that might outweigh the potentially high costs. This year you can contribute $19,000 ($25,000 if you’re 50 or older), which is significantly higher than an IRA’s $6,000 limit. And as Money Magazine notes, you can always move your balance into a new, potentially more cost-effective account when you get a new job—but only if you’ve contributed to it.