30 Day Investing Challenge, Day 22: How To Choose Investments In Your Workplace Retirement Plan
Have you ever started a new job and signed up for your 401k, 403b or other workplace retirement plan, excited to start saving and investing, only to get a huge list of funds to choose from? Have you looked at this list and felt confused by what you should choose? At this point it’s understandable to want to hire someone to help you. Legally the only people who can tell you what to invest in are investment advisors — yep, they’ve cornered that market. But I have a process you can use to do choose for yourself and avoid the hefty fees. This entire challenge day is full of action steps, so get out pen and paper, or whatever you’ve been using to track your challenges, and let’s dive in!
Action Step 1: Opt In
Opt in to contributing a percentage of your paycheck to your account. I recommend starting with 5-10% to ease yourself into the process of investing and not give yourself a huge shock when your paycheck goes down. If you don’t know how to opt in, reach out to HR or the plan administrator, they’ll help you out.
Action Step 2: Determine Your Ideal Asset Allocation
The first step is to remember which asset allocation strategy you chose from challenge day 18. Let’s review:
You can have 100% of your portfolio in stock based index funds if you’re willing to endure the ups and downs of the market.
You could have a split between stock and bond index funds to smooth the ride. The formula for finding the right allocation for you is:
110 - [your age] = % of your portfolio in stocks.
Example if you’re 35 years old: 110 - 35 = 75, so your portfolio should be split into 75% stocks and 25% bonds.
Caveat: your portfolio shouldn’t go beyond a 60/40 split or it’ll be too conservative to keep up with inflation.
If you chose to split up your allocation, write down what your ideal ratio is for the following action steps.
Action Step 3: Note The Fees
We talked about fees on day 8, so you can dig back in and use that challenge to analyze the fees in your own investments. Two big ones to look for are “expense ratios” and “front load.” A good rule is to find a fund with less than a 1% expense ratio and no front load fee. I personally like to keep my fees below 0.25% if possible, however since you’ll have limited options in your workplace plan it’s fine to increase the upper limit of what fees you’ll accept to 1%.
Action Step 4: Analyze The Funds
Review the list of funds your plan offers and note 3 things for each (you can skip over the target date funds — those are the ones with a year in the name, such as “Fidelity Freedom 2055 Fund.” If you want to know why, check out my Instagram post about why I don’t like target date funds):
Look at the asset mix: stocks or “equities”, bonds, and cash — international equities can be lumped in with the stock category. If you’re unsure of what something is, just Google “What kind of asset is [insert confusing term here]?”
Look at the funds’ long term returns — they should be above 8%.* You want your returns to be well above inflation (average 2-4%) and still be able to withdraw 4% once retired.
Note the expense ratios.
You don’t have to write anything down yet, we’ll narrow things down in the next step. This is just to get you familiar with what your offerings are.
Example: Let’s Analyze a Real Fund
Let’s look at Fidelity’s Balanced Fund (FBALX),** something that is offered in quite a few 401k plans:
Asset allocation = 63% stocks/equities, 37% bonds & cash, which is within the 60/40 allocation limit but is still conservative.
Expense Ratio: 0.47%, below the 1% limit.
Returns: 9.38% over 38 years, which is well above 8%.
Action Step 5: Narrow Down Your Options
Create two groups:
The top 3 funds with the lowest expense ratios.
The top 3 funds with a stock allocation that closely matches your ideal.
See if there are any funds that sit in both columns, i.e. overlap, and choose the one with the lowest expense ratio and highest % of stocks that meets your ideal stock allocation.
Example:
Say your ideal asset allocation was 80/20 stocks/bonds, which fund would you choose from the above table? If you chose Fund F, right on! Fund F has a good combination of allocation and low fees. Fund Q’s allocation if way too low even though the fees are lower. Choosing this fund would result in much lower returns because of the high bond allocation.
If the two lists you create don’t have overlapping funds, keep adding more until you do. This exercise helps you determine which option is best out of the small amount of choices you have.
Action Step 6: Automate Your Annual Increases
Most retirement plans allow you to opt into automatically increase your contribution percentage by 1% every year. I recommend doing this if you started with a 5-10% savings rate so you can get up to your ideal savings rate determined on day 17.
The Bottom Line
If one fund doesn’t meet your needs, you can choose multiples (keep it to 2-3 though so it doesn’t become overwhelming). For example, if you’re not 47 but still want to buy FBALX, you can add a more aggressive fund like Fidelity’s Blue Chip growth (FBGRX), which is almost all stocks. If your 401k has a total stock, total bond, or S&P 500 fund then your investing life just got so much easier. You can simply put your ideal asset allocation in each of these funds — for example, if your ideal asset allocation is 80/20 then you can put 80% of your investments in a total stock market index fund and 20% in a total bond market index fund. Easy peasy.
Using this process should help you choose the right investments in your 401k and sift through the confusion. Learning a few simple rules can save you from hiring an expensive advisor who may put you in something that makes them a lot of money, but not you.
I’ll see you here tomorrow for your next challenge: Buying an investment in your self directed investment account (IRA, HSA, or brokerage).
*Past results are not indicative of future returns.
**Information as of April 2024. This fund’s make-up may change over time.
Want to dive in deeper? My investing workbook “Your Journey to Freedom” will show you how to build the life of your dreams and teach you the fundamentals of the investing world.
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