When I started my new job I got a 15 minute presentation from the HR director, explaining that I had a 401(k) and other sundry benefits, and that “the fund selection is really good.” He handed me this sheet of paper and gave me a website to go to in order to set up my 401(k).
I would like to imagine that most people are like me when it comes to looking at 401(k) funds. As I stared at that sheet of paper, I strongly considered just scrapping the 401(k) thing and shoving our extra money under the mattress. But, since I had already learned a little bit about 401(k)s and knew that there are some good benefits for retirement savings and taxes that could come out of them, I decided instead to learn a little bit more about what all of those awful numbers meant. And read some more. And read some more.
To be honest, I still don’t completely understand everything about choosing good 401(k) funds, but I think I simplified things enough to get a somewhat passable investment strategy. I was listening to an interview with Chris Costello from blooom.com, a website that is geared towards simplifying management of 401(k) funds. In the interview, Mr. Costello claims that most people have their funds misallocated – he cites that many young people with 401(k)s have their contributions tucked away in money market funds within their 401(k)…which yields essentially no growth. Plus there’s all of this financial jargon when it comes to understanding the fee structure, “rebalancing” my allocations, etc. It almost seems easier to herd cats than to set up a 401(k).
So while I can’t say that I’m anywhere near an expert when it comes to managing our 401(k) funds, this is my dumbed-down system – it’s probably not super great, but hopefully it’s not awful either.
- I looked at the funds with the lowest fees for the options.
On the first page of fund options, all of the fees were near or over 1% – which, if I understand it correctly, means that even if I were to see 7-10% gains per year on those investments, I would net ~1% less than I would make with funds that were on the second page (where the fees were closer to 0.10%).
- I had to figure out what the different funds actually invested in.
My 401(k) had a few Vanguard funds – which reportedly have the lowest expense fees – but before I decided on which funds to buy and how much to put into each fund, I needed to understand what the funds were and what they invested in. So I made a spreadsheet (as I typically do).
Fund Name Fund Symbol What Companies They Invest In Expense Ratio 1 Year Return 3 Year Return 5 Year Return Vanguard 500 Index Fund (Admiral Shares) VFIAX S&P 500 0.05% +15.31% +17.85% +14.40% Vanguard Institutional Index VIIIX S&P 500 0.02% +15.35% +17.89% +14.43% Vanguard Mid-Cap Index Fund (Admiral Shares) VIMAX Index of mid-sized companies 0.09% +18.33% +19.66% +15.72% Vanguard Extended Market Index VIEIX Index of small- and mid-sized companies 0.08% +15.04% +19.40% +15.30% Vanguard Small-Cap Index Fund (Admiral Shares) VSMAX Index of small-sized companies 0.09% +13.99% +19.49% +14.92% Vanguard International Growth Fund (Admiral Shares) VWILX Index of international companies 0.34% +5.15% +11.42% +8.26% Vanguard Developed Markets Index VTMNX Index of Europe and Pacific companies 0.07% +3.39% +11.98% +6.78% Vanguard Emerging Markets Stock Index VEMIX Index of stocks in emerging countries 0.12% +11.17% +4.17% +3.30%
Based on what I found out about the general goals of each of these funds, I basically got a sense that among the U.S. stocks I could invest in different sized companies, and I could also invest in international companies. Sure, there were also bond funds available but because we’re still pretty young and don’t plan to withdraw these investments for at least 25-30 years, I figure around 90% of our total portfolio should be in stocks.
- Split up the money in the 401(k)s to reflect a specific investment strategy, rather than trying to chase gains that may or may not be there in the future.
Most investment sites warn, “past performance is not indicative of future returns” or something like that. While it would not be wise to decide investments expecting exactly the same returns as they’ve been in the past. At the same time, the longer-term yield numbers can give an idea of what to expect on average through good and bad times.Based on the various things I’ve read, there are tons of ways to split the money, but the important thing is to pick one allocation and stick with it. So we decided that 70% of the stocks should be in U.S. stocks, 20% should be in international stocks, and 10% should be in bonds. Most of the U.S. stocks would be in the S&P 500 indexes (since they represent the biggest companies in the U.S.), but investing in the mid- and small-sized companies would provide additional diversification. The international funds would also allow for more diversification.
Now, hopefully everything works out well in the long term. Of course, if either of us lose/change our jobs we’ll probably roll our 401(k)s into a traditional IRA and then re-evaluate the fees to make sure they don’t become higher.