The investing landscape has changed dramatically over the years. Rather than calling a stockbroker to place an order, most investors now login to their e-broker to place an order. Instead of investing in expensively managed funds, many investors now choose to invest in passively managed exchange-trade funds (ETFs). A broader range of securities is available today as well. Some ETFs track niche investments that would otherwise be difficult to replicate. For example, iShares offers an ETF which solely tracks Peruvian stocks ($EPU). Within a typical 401(k), however, investment options are limited. Still, making the decision of how to allocate funds can be confusing, even intimidating. There are a few general principles all 401(k) participants should be aware of.
Younger investors tend to invest a large percentage of their investments in stocks.
Stocks historically have yielded higher returns than bonds and other popular assets. Since the inception of the S&P 500, a collection of the 500 largest U.S. stocks, which is rebalanced quarterly, the S&P 500 has yielded about 7% when adjusting for inflation (assuming dividend reinvestment). Most 401(k) plans offer ETFs or mutual funds which invest in domestic and international stocks.
As investors approach retirement, investors tend to diversify their portfolio.
While stocks have historically posted sizable returns, they’re relatively more volatile than other asset classes. For those who do not need their retirement savings in the near future, stock market volatility can be tolerated. However, those approaching retirement-age seek to preserve their wealth by holding a large portion of their portfolio in bonds, REITs and other assets. Target-date funds are an easy way to automate this process. As target-date funds approach their target-date, the funds automatically shift to bonds and other assets.
Investors should carefully consider management fees.
The management fees for funds can vary considerably. While the difference between a 0.2% and 1.0% management fee may appear trivial, in the long run, the difference compounds in the form of lost returns. When accounting for fees, expensive funds often do not beat their benchmark. Moreover, be wary of expensive funds.
While 401(k) investment offerings may be limited, it is crucial to make educated allocation decisions. If a 401(k) does not offer the types of investments desired, consider their 401(k) as a component of their complete portfolio of investments. For example, if a 401(k) does not offer a bond fund, consider investing your 401(k) in stocks while investing your IRA in bonds.