Over 50 million Americans are currently owners of 401(K) retirement accounts. If you are one of them, you expect a quarterly account statement that shows the status of the account along with other relevant information. You will be asked to come up with ways to invest the cash and confirm the same from one year to another. There are several ways you can invest the cash depending on your provider. You stand a better chance of making a good investment decision if you know the various ways you can invest the cash.
The 401(k) sponsor in many cases is your employer. He is the plan fiduciary and is legally responsible for aiding you in selecting the right investment options and monitoring the progress of your funds. Many plans offer you up to five investment options for your cash. However, several offer up to 12 alternatives. The most common investment products include company stock, variable annuities, mutual funds and guaranteed investment contracts. You will also find some plans offering you brokerage accounts from which you can select a few of the above investment options. Despite being allowed to plan your investments, some funds restrict your access to the matched contributions from your employer. However, many of the employers will follow your investment decisions on the matched contributions
Types of 401(k) Investments
Mutual funds are the most common type of investment available for the 401(K) investments. This is an investment where the company pools together fund from different investors and put it in specific investment goals. Most mutual funds invest in a combination of all these investments. Investors share gains made by the funds proportional to the amount that they had invested. The fund managers generally make all investment strategies for the fund.
This option is mostly available in the public-traded companies. Unfortunately, the menu in many of these plans includes a fund that you can only use to buy the company stock. Many employers also encourage their employees to choose this option. This is because doing so improves an employee’s commitment to the company and helps reduce employee turnover. The most common motivation for this kind of investment by employers is allowing employees to buy the stock at a lower-than-the-market price or matching the investment with more than the employees are contributing. This investment can be a good decision in the short and middle term if the company stocks are doing good. However, choosing this as your long-term investment plan is likely to put your finances to a greater risk of a loss.
If your 401(k) has a brokerage window, you have the option of investing in an assortment of securities that includes bonds, stocks and other instruments in the money market. You are in full control of your account. Therefore, you can order buying and selling of the securities as you wish. This option may be good if you are good at money-market investments. Given that tax is differed in 401(K), you are not required to file tax for any capital gains that you make from the investment. However, if you make any withdrawals from the traditional 401(k) account, you are required to pay income tax.
On the downside, the brokerage account charges commissions and fees for every transaction that you complete at the account. Some mutual funds that you buy using the account may be a lot more expensive than buying using other ways due to the high fees charged.
Variable annuities differ from the rest of the products explained above because it comes with an insurance option. This hybrid insurance product combines several funds with forms of insurance protection.
Decisions to Make on Fund Allocations
If there are several options available and you would like to diversify your investment, you must decide how you will allocate the available funds among various investments.
Consider Target Date Funds
Target date funds denote the date that you plan to retire. The date is indicated on the fund. When you take the fund, you are supposed to estimate the date when you are likely to retire then pick a fund that is close to that date. Most target-date funds spread your cash across various assets that include real estate stocks, company stocks and emerging markets. The management of the find decides how much of the cash will be invested in what project and does not require your input. As your target date nears, the fund gets conservative on the investment decisions it makes to reduce risk so that there will be cash when you start making withdrawals.
A Balanced Fund also Works Well
A Balanced fund primary allocates funds on both the stocks and bonds at a ratio of 40% for the bonds and 60% stocks. The advantage of this allocation is that the investment is not caught up in the market volatilities when there are rises and falls in either of the two markets. This option works well for people who are not sure when they would like to retire. Such people go for investment products that are not too aggressive or risky and not too conservative as to bring meagre returns. Just like the target date fund, you do not need to determine your cash allocations as the fund managers would decide for you.
You can Work with a Model Portfolio
If you do not intend to use either of the options stated above or none is available, you may consider going for model portfolios. These portfolios use a mathematical formula to determine how funds would be distributed among various assets. Investment instruments are arranged as per the perceived risk and the rate of returns. Investment professionals construct the portfolios with each option having the right mix of risks and returns.
If you are not working with any financial adviser, consider using one of such portfolios to make your investments. The professionals can help in picking investments according to your risk appetite, retirement goals and preferences. You can use such assistance to maximize returns where your spouse also contributes to a separate 401(k) account. Portfolios also ensure that you are disciplined in your investment decisions and are not swayed by the current market forces.
Spread the Funds Equally Across Various Options
If none of the above options is available for your 401(K) plans, you may adopt a plan to spread out your investments across various options. This helps achieve a balanced portfolio. Here is an example, if you have ten available options, you may invest in all ten at 10% of the funds in each. All you are required to do is to pick an investment in every option that is on the table. Given that most categories such as money market, bonds or bonds have other smaller options within them, you might end up investing between 15% and 20% in every major category. However, only choose this method when all the other options are not available.
Your investment decisions on the 401(k) funds will determine how much you are going to make with your retirement funds before retirement. Take a critical look at the available options and pick a plan that balances the return on your investment as well as the risk involved. The very competitive markets may have a high return but high risks too. On the other hand, very conservative decisions may bring very low returns. Your investment decisions should cut in the middle.