Learn about how to select investment choices in your company’s 401k.
How do I choose investments in my employer 401k?
If you’re an employee, and you participate or would like to participate in your employer’s retirement savings plan, but don’t know where to start, here are some basics!
First, ask the HR team at your company whether you are qualified to enroll in your company’s retirement savings plan, often called a 401k. (403b, 457b are similar retirement savings plans sponsored by employers.)
Next, ask the HR team whether your employer makes any contributions to the plan on your behalf. Some employers make a matching contribution, which matches your contribution up to a limit. Other employers make a contribution that is not based on how much you contribute but is based on other factors the employer defines. Ideally, you want to maximize the amount that your employer contributes on your behalf because it’s almost like free money you may be able to use towards retirement.
Then, you’ll select how much you want to contribute from your paycheck. You usually have a choice of a set dollar amount, or a percentage. I often recommend my clients choose the percentage because it will automatically increase as your salary increases. But you choose what’s best for you.
Finally, you’ll choose your investments. But wait, that can be confusing. How to choose?
401k plans typically have about 20 or so fund choices, but there are usually only two general investment choices available: target date funds, and individual funds.
Target Date Retirement Funds
Target date retirement funds are so-called because they are a combination of holdings that adjust over time as the “target date” of retirement approaches. They are a simple way of choosing only one fund that offers diversification of several types of holdings inside that one target date fund, such as stocks, international stocks, bonds, cash.
Target date retirement funds usually have the target date in the name, such as “2065 Target Retirement Fund”. This fund assumes that its investors plan to retire in the year 2065, so its holdings are adjusted over time to prepare for retirement.
The adjustment over time is also called a “glide path”. Here’s a sample glide path from Vanguard. The circled numbers at the horizontal axis reflect the participant’s age. You can see that in this example, during the “early career” stage of 20s to 40s, the holdings are mostly the light and dark greens of US and international stocks. In the “withdrawal” phase from age 72 to 95, the fund holds mostly yellows of bonds and short-term TIPS (a type of fund that offers inflation protection).
Target date retirement funds can be good choices for investors who want to choose a more passive style of investing, letting the fund manager adjust holdings automatically over time based on the glide path.
To choose a fund, decide how old you will be at retirement age, then add that number to your birth year. For example, for a person born in 1980 who wants to retire at age 67, a fund dated 2045-2050 could be a good option. (Not personal investment advice.)
By individual fund, we mean funds that have a specific and more narrow investment, such as a 500 Index Fund (usually holding the largest 500 companies in the US) or the Total Bond Market Fund (usually holding a variety of US government and corporate bonds). These individual fund choices vary widely by 401k plan. They can be good options for a investor who wants to select their own portfolio of investments.
For example, there may be a fund with “Growth” in the name. This could be a fund that specifically holds stocks of individual companies identified as growth companies. A growth company is typically expected to grow sales or earnings significantly above average in the future. Tesla is an example of a growth company in 2023.
Several of the individual funds found in a 401k could be used to build a portfolio that has the amount and type of holdings that you personally prefer, such as a certain percent US stock, international stock, or US bonds.
If you don’t choose any investment, many 401k plans will automatically enroll you in a target date retirement fund based on your age.
Use available tools to educate yourself
If you have questions about the best investments for you, or want more education about the investment choices, try calling your employer’s 401k administrator. This number can usually be found on your statement. There may also be a variety of education-related materials on the 401k administrator website. Spend some time browsing the available tools and information to education yourself about what might be best for you.