You graduated college and landed your first job. Congratulations! Now you are staring at this form that is having you pick what investments you want to invest inside your 401k plan. This can be an overwhelming time as most people have never invested up until now.
What funds do you pick? Do you pick based on how well they performed in the past? Or do you just close your eyes and point and whatever fund your finger lands on is what you go with?
This post will walk you through your options so that you get the most out of your 401k plan and set yourself up for investing success.
5 Tips To Invest In Your 401k
#1. Ignore Past Performance To An Extent
Your first step is to ignore past performance. At least for the most part. Don’t look at the recent past to see how well or poor a fund did. Instead, look at the 10 year return. For stock funds, you would like to see that number be around 8%. For bond funds, it should be around 5%.
This first step will allow you to cross out some funds right away. But you aren’t investing in what is left. You still need to narrow the list down.
#2. Review Expenses
Your next step is to review the fund expenses or management fees. For this one, you will see a wide range of percents. Just know that in this case, lower is better.
For stock funds, you want a management fee under 1%. For bond funds, you want a management fee under 0.50%. You can cross out anything above these limits.
The reason you do this is because this is the fee you pay to invest in them. You will never be physically billed. The fee comes out of the return of the fund itself. So the lower the fee, the more money you keep.
#3. Review Your Overall Asset Allocation
Now you probably have a small list of funds remaining. What do you do now? You have to diversify so that you can balance risk. Now some experts might tell you that you need to have a bunch of funds to be diversified. But this isn’t entirely true.
You can get by with just 3 funds: a large cap, an international and a bond fund. At the very least, a large cap fund and a bond fund is what you need.
Because each 401k plan is different, what you invest in will be different for everyone. The key thing to remember is that you can get by, and be just fine with 2 or 3 funds.
#4. Make Tweaks If Needed
To take the above point one step further, in addition to your 401k plan, you might also be investing in a Roth IRA. If this is the case, then you have many options.
You can just pick the lowest cost funds in your 401k to invest in and then round out your diversification in your Roth IRA.
So for example, let’s say you have a large cap fund and a bond fund in your 401k plan that meets your criteria. You invest in those 2 funds there. In your Roth IRA you can invest in small cap and international funds.
Note that if you do any investing outside of your 401k plan you can use it to round out your diversification. I just used a Roth IRA as an example.
#5. Invest In Your Company
Finally, if you work for a publicly traded company, you can also invest in your company stock through your 401k plan.
Note that if you do this, limit the amount you invest to a maximum of 10% of your overall portfolio value. You have to make sure you monitor your balance over time and take money out of company stock when it goes over this 10% limit.
The reason is because it is risky to invest in your company stock. If the company goes under, the stock price will be worthless. Not only are you out of an income because you lost your job, but if you only invested in your company stock, your retirement savings are wiped out as well.
So the moral is to keep any investment in your company stock to a small percent of your overall portfolio.
Finally, if you work for a small company, investing in your company stock through your 401k plan can allow you to get exposure to small cap stock. Many times the fund expenses for small cap stocks is higher than 1%.
Investing in your 401k plan might seem overwhelming at first if you never invested before. But if you follow these tips, you should make out fine over the long run. You will be investing in good quality funds and keeping your expenses to a minimum.
Just remember to limit your exposure to your company stock if you decide to invest any money there and to round out your diversification in other investing accounts if need be.