In this article we focus on helping you make choices in your employer’s retirement plan.
Most employers offer some type of retirement plan to employees, including 401(k) plans, 403(b) plans, section 457 plans, SEP-IRAs, and SIMPLE IRAs. In most cases, the employee is given the option of making contributions to the plan and is then able to choose how to invest the money from a given list of investment choices. For the new investor, this can sometimes be a difficult task. Many questions arise: Should I pick the fund with the best return; Should I diversify among many different funds; How should I choose which funds best suit me?
Step 1: When Will You Need this Money?
Henssler Financial believes the best way to determine your asset allocation inside your retirement plan is ask yourself when you likely will need the money you are saving in your retirement plan. We believe that funds needed within 10 years should be invested in fixed income securities, and funds not needed in ten years should be invested in equities. Therefore, unless you are entering the workforce at a later age, you likely won’t need the funds in your retirement plan for at least 10 years. Withdrawals from a retirement plan before age 59 ½ currently are subjected to a penalty tax of 10%, in addition to the regular income taxes that must be paid on the early withdrawals. Mandatory withdrawals from retirement funds are not required until the account holder reaches age 70 ½, at which point the law dictates that you must begin withdrawing funds from your retirement accounts. So, your first step should be to estimate whether you would need any of the funds in your retirement plan in the next 10 years.
Step 2: Invest Funds Needed within 10 Years in Fixed-Income
If you determine you may need some of the funds you are saving to your retirement account within the next 10 years, we suggest you consider investing the portion you may need in either a money market fund or a short-term bond fund. Long-term bond funds or funds that invest in bonds that mature in 10 years or more, should be avoided, as the risk to principle is too great. The whole reason you are investing money in bond funds, or money market funds, is to protect the principle that you will need to eventually withdraw within 10 years. Funds that invest in fixed-income securities will often have the word “income” in the title, although some income funds also invest in stocks that pay healthy dividends. You shouldn’t switch your contributions into bond or money market funds because the stock market gets “scary.” Scary stock markets often provide the best times to buy stocks at relatively inexpensive prices. You should also avoid balanced funds, as we prefer that you keep your equity portion of your savings in equity funds, and your fixed-income portion in fixed-income. Balanced funds often muddle this mix, making it more difficult to tell how much exposure you truly have to the equity markets.
Step 3: Invest All Other Funds into Equity Funds
All funds that you don’t believe you will need within 10 years should be invested into equity funds. Your contributions should be allocated 100% each paycheck into equity choices within your plan. If you have held a portion of your plan savings out of equity funds, but are now ready to begin moving these funds over, you should take a dollar-cost-averaging approach. Plan how many months you would like to take to move your money market or bond fund balance into equity funds. We suggest 12-15 months. Each month, move approximately the same amount from the fixed-income fund to an equity fund.
When determining which equity funds to invest in, we suggest you look at a few things. First, if an S&P 500 index fund is offered, we suggest you make this your core holding, and invest at least 50% of your funds earmarked for equity funds into this option. Other equity funds also should be considered. Again, Henssler Advice provides a list of our firm’s recommended mutual funds. Morningstar is also an excellent source of mutual fund information. It can be found online or at most public libraries. You should consider a mix of funds that match your risk tolerance. Small-cap and mid-cap funds are usually more volatile than large-cap funds, but often offer slightly higher long-term returns. You also may want to consider your mix of growth funds and value funds. (See the article explaining growth vs. value in Henssler University.) Growth funds are generally more aggressive than value funds.
One mistake often made is to over-diversify by buying many, many different funds. Often, you might own three different large-cap funds that all invest in basically the same group of stocks! You never should need more than five or six funds in your retirement plan, at the very most.
Step 4: Review Your Account Regularly
You should review your retirement plan account regularly. However, you should avoid “chasing returns” by moving money out of one fund into another simply because a different fund had higher returns. Many funds that were heavily weighted in technology did extremely well during 1998 and 1999. Those same funds under performed during 2000, when many of the technology stocks performed extremely poorly. The people who were truly hurt by this were those investors who waited until the end of 1999, then moved large sums into these funds because the returns were high. It’s important to compare your funds to other similar funds, and make changes if your fund is not performing as well as it should. One great measure of this is the “Category Ranking” feature Morningstar assigns to mutual funds – this measure compares a fund to funds with similar investment styles.
Next, we’ll complete our series on new investors by providing suggestions for other savings, including IRA contributions, and savings in regular brokerage accounts.
This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
