By Haddon Libby
Do you have a 401k or 457b plan with your employer? Saving as little as $5/day or $100/month, turns into $166,000 over a 30 year career (assuming an 8.5% rate of return). If your employer has a matching program, you will have twice as much.
Your 401k is a nice way to keep paying less in taxes. Every dollar that you contribute grows tax-free until you withdraw your money in retirement. If you do not like the idea of paying taxes on years of growth and gains, contribute money after-tax today via a Roth 401k. Most employer plans have this Roth option.
For most, choosing mutual funds to invest in is a challenge.
For someone who wants a simple, easy to follow investment approach, a target dated fund is a great option. With this investment type, the fund manager adjusts your mix of assets based on the age at which the typical person would retire. This means that a 30 year-old might consider use a 2060 fund while a 50 year old might use a 2040 fund.
Whatever your age, if you want 80% invested in equities and 20% in fixed income, you might want to pick a mix of funds from what is typically fairly confusing list of choices. To keep this a bit simpler, make equity decisions first and fixed income choices second.
When choosing equity funds, it might help if you knew that roughly 60% of all stocks globally are companies located in the United States. Additionally, about 80% of all stocks are invested in large cap companies, 15% in mid-cap stocks and 5% in small cap stocks. If we burrow down a little deeper, about 20% of stocks globally in the technology sector, 15% in financials, 12% in healthcare, 12% in consumer cyclicals, 10% in industrials, 10% in communications, 9% in consumer staples with the remaining 12% in materials, energy, utilities and real estate. Consider these basic percentages when choosing your 401k funds.
When it comes to bonds/fixed income, it is useful to know that we are at the lowest rates in the history of the world. Returns for bond funds have been great in 2020 despite these low rates as funds go up in value when interest rates are falling. This is because the older bonds that pay higher rates are worth more as rates decline. As we are now at interest rates that are lower than the inflation rate and close to zero percent, it is unlikely that interest rates will go down much more. This means that the low interest rates that these funds pay are largely spent on fund expenses and 401k plan management fees.
As interest rates are so low, many investors are holding more in equities than they might if bonds paid more. Many investors are also taking on more risk by holding high yield bonds. High yield bonds pay more in interest rate but come at the price of holding debt by companies that may hold more debt than they can afford to repay. Coming out of a pandemic, holding the debt of the least creditworthy is a risky gamble for a minimal return.
While choosing your investment mix, pay attention to mutual fund costs. Reducing your costs by just 0.5% over the life of your retirement account means 10% more in balances at the end of 30 years.
Lastly, beware of annuities that promise above market returns. There are no free lunches in life or with investments and anything that sounds too good to be true probably has some fine print that warns you about the high costs and potential performance of your investment.
If you need help with investment ideas for your retirement account or another part of your financial life, drop me a note and we can talk by phone, email or Zoom conference call.