My background, often makes me the recipient of random financial advice texts from friends and family. The most common by far is, “What should I pick in my 401k?”.

My head usually explodes when this question is asked. It’s the equivalent of walking into a physician’s office for the first time and asking “Doctor, do I need surgery?” without any further information.

To be clear: your 401k plan is as unique as you are. Without knowing the fund offerings of your 401k plan, your investments outside of your 401k, the type of job you have, your annual expenses, your goals, and your risk tolerance, there’s no way for a financial advisor to tell you which funds are the best for you. Having said that, there are general tips that you can apply when making decisions related to your 401k.

Fees, Fees, Fees

No matter what options you end up picking, ALWAYS check the “expense ratio” of the funds from which you are selecting. There are very few factors under your control when it comes to future investment results, but one that you DO control is the investment fees you pay. The range of fees can vary significantly. According to the Investment Company Institute, in 2019, the average expense ratio of actively managed equity mutual funds was 0.74% compared to passive stock mutual fund expense ratios of 0.07%. This means that the bill on the $100,000 invested in your 401k could be $740 or $7 a year. Assuming 5% growth per year on that $100,000 for the next 20 years – if you stay in that expensive fund you would have spent over $33,500 on fees. That is roughly one-third of your original investment. Nuts. 

Asset Allocation Matters

Asset allocation, which sounds like it could be the title of a spy movie, simply explains the mix of stocks, bonds and cash in which you decide to invest. Research has found that this decision accounts for a significantly larger portion of your overall portfolio risk than the bonds or stocks that you might individually pick. Broadly speaking, the younger you are the larger the share of stocks you should have in your 401k. As you approach retirement there should be a more balanced mix between stocks and bonds as you switch from only caring about growing your money to also caring about preserving your money. 

Autopilot Sounds Good… But Which One?

Nowadays, there are 401k funds that basically use autopilot to shift your asset allocation from stocks to bonds as you get older. They are called Target Date Funds. Let’s say you plan to retire when you are 60 and you are currently 40. That means you would pick the 2040 Target Date Fund since that’s your goal retirement date. These funds can be a decent option as they take care of changing that mix for you, but make sure you check the fees on the Target Date Fund your firm offers. For instance, Vanguard’s 2040 Target Date Fund charges 0.14% while Fidelity’s charges 0.75% yearly fee. In other words, Fidelity’s is 5 times more expensive than Vanguards.

Separately, it’s important to note that the actual mix of bonds, stocks, and cash of Target Date Funds vary widely. This means that just because Target Date Funds have the same target date of retirement, their portfolio mix is not the same. Check out the table below that looks at the percentage of stocks that are in each of these Target Date Funds by the time the employee hits 65. Yeah, there are some big differences there right? John Hancock’s Target Date Fund has less than 10% in stocks, while Fidelity’s still has 55% in stocks.