By Samuel Taube 401(k)s give you a lot of advantages in planning for your retirement. Your employer matches some portion of your contributions, and you can borrow from them when it’s absolutely necessary.
But there’s one major disadvantage they have compared to IRAs. Some employers make you choose from a limited set of mutual funds. If you’re not familiar with the funds available to you, it can be difficult to put together a decent strategy for your retirement.
Let’s go over the basics of how to choose mutual funds for your 401(k).
Goals and Risks
Perhaps the most important aspect of how to choose a mutual fund is your goal. How much are you looking to grow your money? How long do you have before retirement? And what level of risk are you willing to tolerate?
To some degree, the answer to all three questions should depend on your age. If you’re younger, and just starting to save for retirement, then you should be very risk-tolerant. You have decades to grow your money, so you should invest in high-growth assets, even if they come with more risk. If the market crashes on you, you’ll still have plenty of time to recoup your losses.
However, if you’re a middle-aged investor, then stability should be your main concern. If you’re not that far from retirement, then you’ll need to start withdrawing from your 410(k) soon. That means you want to minimize your exposure to market risk, and pick reliable funds that will grow slowly or maintain their value.
Target-date mutual funds are becoming increasingly popular, and for good reason—they do all the risk-planning for you. You just pick the one with your intended retirement year on it, and voila, you’re allocated correctly.
But if you’d rather choose your risk-tolerance yourself, this table should help.
Younger investors
Older investors
Growth and smallcap funds
Bond funds
Value funds
Money market funds
Emerging markets funds
Domestic bluechip funds
Dividend funds
Dividend funds
It’s pretty easy to see the pattern. Younger investors should put their money in funds which will gain rapidly and are a bit more risky. Older investors should put their money in safer funds which will hold their value.
You might have noticed that dividend funds are in both categories. That’s because dividend stocks tend to be very stable companies which pay out their earnings to investors, making them ideal for older folks. However, those dividend payments can be reinvested to buy more shares, which can cause returns to grind exponentially higher over a long period of time. That’s why younger folks find them useful, too.
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Expenses
Another important consideration in choosing mutual funds is how much each one costs.
Mutual fund managers generally extract their pay from investors in two ways. Certain funds charge one-time fees on deposits or withdrawals. Others have expense ratios which are collected as a percentage of the fund’s returns, sort of like a commission. And some have both.
If you’re interested in a fund which charges fees, make sure those fees are less than 6% of the initial investment. If you’re choosing a fund with an expense ratio, it should be under 1%. And …read more
Source:: Investment You
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