Recently, Corey posted on How to Start Saving for Retirement. I wanted to take this a step further and help out the readers with how you should invest your retirement savings.
When I first started working, I had a good idea of how I wanted to invest the money I was saving in my 401(k). I think this was because finance is what I went to school for. Many of my friends would ask me to help them out with picking their investments in their 401(k) accounts. When I would see their statement of what they were currently invested in, it saddened me.
I saw everything from leaving everything in cash, to 100% bonds, to one friend dividing up his investments into nine different funds. Nine! When I approached him about this he said that since there were so many options, he thought he was supposed to choose a bunch of them.
The main theme I heard from most is that they were overwhelmed. They had no idea what to invest in. Most simply looked at how the funds performed in the past and picked the ones with the highest returns. Even the benefits person at their place of employment that they were told to call with questions didn’t help out. Luckily, help is here.
Your first step is to get a complete list of all of your investment options in your 401(k) along with the management fees the funds charge. You should have an enrollment booklet from when you were hired. If you don’t have it, contact human resources.
Once you have this information, you are to pick three funds to start: A domestic stock fund, an international stock fund, and a bond fund. You will invest:
- 50% in the domestic stock fund
- 30% in the international stock fund
- 20% in the bond fund.
This will give you an 80% stock, 20% bond portfolio.
For example, if you save $100 per month, $50 goes into the domestic stock fund, $30 goes into the international stock fund, and $20 goes into the bond fund. If you are just starting out, you should be able to handle this amount of risk. If this is too much risk for you, then you can lower your stock holdings to 60% stocks (40% domestically and 20% internationally) and 40% bonds. I don’t recommend going lower than this since you have close to forty years until you will need this money. You need the money to grow and can afford the risk at your age. If you are still nervous about the risk, read the benefits of compound interest. This hopefully will sway you. If note, you can follow my plan when you are scared of the stock market.
I cannot tell you the exact funds to pick, as everyone has a different 401(k) plan and different investment choices. I can tell you this though: Look at the management fees. If any domestic stock fund has a management fee over 1%, cross it off the list. It is too expense. Ideally, you will want something that compares itself to the S&P 500 Index. If you don’t have anything that does this, then pick a large cap fund.
When it comes to international stock funds, I hope that you can also cross out anything that charges more than 1% in management fees as well. However, judging by what I see, most of you won’t have this option. My advice is to look for an international fund that invests in the entire international market or an emerging markets fund. If you have multiple choices, pick the one with the lower management fees. If all of your international choices charge you more than 1.25%, then do not invest in an international fund in your 401(k). You can do so in a Roth IRA or Traditional IRA and pick something with a much lower management fee.
For your bond fund, pick a fund that invests in the entire bond market. If you don’t have that choice, look for a short-term bond fund. Again, look for a management fee under 1%.
I do not recommend looking at the target date funds. They aren’t all they are cracked up to be. They are riddled with fees and don’t do as good of a job as they claim.
I hope this clears the air for many new employees investing in their 401(k) plans for the first time. If you have any questions, please comment below or email me and I will be more than happy to help you out. I cannot pick the exact fund for you to invest in, but I can guide you.