Making your 401k Plan Work for You
Over the past two weeks we have looked at the expenses associated with 401k plans and the role of the trustees who oversee your plan. Today we are going to focus on how to make your plan work for you.
As you consider your plan, pay attention to the quality and breadth of your investment choices. The menu of possible investments should be broad enough to give you the building blocks you need to create a resilient and well-diversified portfolio.
At a minimum, your plan should have funds from the following asset classes: large cap U.S. stocks, small cap U.S. stocks, international stocks, investment grade bonds and cash. A more complete array would divide the large and small cap U.S. stock categories to include growth and value styles, while international stocks would be divided between developed and emerging markets.
The best plans include low-cost, passively managed funds, such as index funds. Management fees are a drag on long-term performance. The more you can reduce fees without compromising quality or discipline, the better your plan will work for you.
If your plan doesn’t give you an adequate array of asset classes or funds, talk with your plan’s trustees. It costs very little to add a fund to the lineup. However, a plan can have too many investment options. If your plan has more than 20 funds, you probably don’t want to add any more. In fact, if there are more than 20 funds, your trustees may want to look at culling the herd.
Many people struggle with how to allocate among the funds in their 401k account. They either have an allocation that is too conservative (i.e., too much invested in bonds) or that is overly concentrated in one or two funds. Both approaches work against your long-term success. Instead, build a well-diversified portfolio that is appropriate for your investment horizon.
As you think about your investment horizon, remember that your horizon is not your retirement date. According to actuarial studies, a 65 year-old in reasonably good health has a 25% chance of living another 30 years. So, if you are retired or approaching retirement, remember to think long-term.
Many plans include target-date funds to help participants manage their investment allocation. A target-date fund is managed with a particular horizon date in mind. As the target date approaches, the fund’s asset mix shifts to include more bonds and fewer stocks. The schedule of changes in the fund’s asset mix is referred to as the fund’s glide path. You can usually find the glide path buried deep in the fund’s prospectus. For example, Vanguard shows the glide path for its target-date funds on page 76 of its prospectus.
When choosing a target date fund, look at the glide path, not the fund’s target date. Unless you have special considerations, a glide path that gets you to a mix of 60% stocks and 40% bonds at retirement should be a pretty good fit. As always, if you need more specific advice, I encourage you to see your financial advisor or the advisor to your 401k plan. If your 401k plan does not include target-date funds, you can use the glide path of other target date funds to help you get a sense of how to set your current asset allocation.
You play a vital role in making sure your 401k plan works for you. Plans are sometimes less than they could be because plan trustees get caught up with other pressing concerns—especially in small companies. You can help the trustees fulfill their fiduciary duty by sharing your concerns and suggesting possible improvements.
Steven C. Merrell MBA, CFP®, AIF® is a Partner at Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey. He welcomes questions that you may have concerning investments, taxes, retirement, or estate planning. Send your questions to: Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to: firstname.lastname@example.org