When you start a new job or your employer gets acquired, you may need to make retirement plan decisions on the fly. While you probably have the option to change your investment selections at any time, inertia is the most powerful force in personal finance. Your short-term choices may persist for years to come.
Whether your 401(k) plan resembles a Chinese menu with scores of regional dishes or a menu del dia with a few selections, choosing the right investments is critical. Depending upon your employer for investment advice is rarely helpful. They may provide generalized assistance after their form identifies you as “aggressive” or “conservative.” They rarely have the information and expertise to provide you with adequate guidance.
Finding impartial advice on your retirement plan options can be challenging. Even independent financial planners may be reluctant to delve into the details of your plan, as the investment options can vary significantly from employer to employer. If you’re like most investors, you are essentially left to keep your own counsel. To make this task a bit easier, remember these tips.
Consider your whole portfolio. It’s natural to mentally segregate our investment accounts and assign a purpose to each one of them. You might say your 401(k) plan is only for retirement and so it should be invested for the long-term. This is relatively straightforward if your 401(k) is your only significant asset.
If you have other investments, you need to consider them as well when devising an appropriate strategy. For example, it could be that it makes sense to concentrate your 401(k) in more conservative bonds for tax reasons.
Low costs predict success. One of the strongest, more reliable predictors of an investment’s success is its cost structure. This is one area of your life that you don’t get what you pay for. The higher your investment fees are, the more likely it is that you will achieve subpar returns.
Hopefully you can easily determine the fees associated with each investment account. If not you may need to compare the returns of investment options against a relevant index, such as the widely used S&P 500, to approximate the investment fees.
Avoid company stock. You’re already invested in your company. After all, you work there! Your future cash flow in the form of income is dependent in part on the future of your company. You wouldn’t want to see your company suffer through a downturn, have your investment holdings tank, and then find yourself, as the British say, being “made redundant.”
Watch portfolio turnover. The turnover of a portfolio is expressed as an annualized percentage and relates to the stability of a fund’s investment holdings. A fund with 100 percent annual turnover replaces its entire portfolio on average once per year.
It may be that such a fund will hold a favorite stock for five years, but then there will be others that are held for less than a year. Funds with turnover ratios of more than 50 percent have high costs that are not included in the widely publicized expense ratios that must be overcome to achieve market returns.
Also when funds purchase and sell stocks, like you they pay brokerage commissions that detract from total returns. Also, the difference between what the stock seller receives and the buyer pays is called “the bid-ask spread,” and is another hidden cost that’s dearer for funds with higher portfolio turnover.
While there are many factors to be considered when choosing retirement plan investments, these four tips will give you a better chance of avoiding the dogs and getting the right portfolio in place to achieve your goals.