My wife recently started a new job and – along with the mounds of intake information, tax forms, and health insurance brochures – she received a packet explaining her retirement plan. Given my background in financial planning, I made sure to sit down with her and talk about the plan options, explaining why something may or may not be a good choice. If you haven’t gone through this exercise before, here are some things to keep in mind.
Are you comfortable with investment risk?
When you read the brochure or go on the plan provider’s website, you’ll see sections about risk tolerance or your comfort with risk. In investing, the simplest way to think of risk is the chance that your money will lose value. You may think that can only occur through volatility, and while stocks will gain and lose, you can also lose value by refusing to invest at all due to inflation. In the end you have to decide how much of the different types of risk you’re comfortable with. That is, are you more worried about an investment losing value or your money losing value sitting in a bank account earning less than 1%? There are online risk evaluations and your plan provider may also include an assessment to help you determine a comfortable level of risk.
One caveat: you can read all the quizzes and online suggestions (and this article) and assume you’re fine with risk. The question that gets to the heart of the matter: how do you feel when you lose money? In the last two years, the markets have see-sawed, first with the COVID correction and lately with losses due to government responses to inflation, the war in Ukraine, etc. Have you seen this as a chance to buy more since your investments are on sale, or are you awake at nights wondering when you can get out of the markets?
Determine your asset allocation
In a nutshell, the younger you are the more you should invest in stocks. While some people use outdated rules of thumb, most suggest you balance your comfort with risk with your goals to determine your asset allocation. Some may be comfortable investing 100% in stocks; others may want no more than 25% in the riskiest categories. Again, if you’re young and not comfortable at all with risk, you may choose to ignore the financial experts saying invest 100% in stocks and find an allocation that lets you sleep at night.
Now look at your plan options
Most retirement plan brochures or websites categorize your investment options depending on asset classes, usually split out between bonds, stocks, and stability of principal/money market funds. Some will dive deeper and split your investments into balanced funds, large/mid/small cap funds, and even target date funds. It all probably seems very complicated.
If you are new to retirement plans, I suggest taking some time to read about each asset class. Yes, there are many more enjoyable things that you could do. But learning this once – early on – will make subsequent decisions much easier if you change jobs or get new plan options. For example, I do not invest in target date funds. I’ve researched them and found that I can do better and save on fees by using other funds. This isn’t to suggest you do that. But if you decide you’re comfortable investing in stocks (for instance) and they still make sense for your goals, in the future you can skip everything but the stock section, then drill down there to make your decisions.
Fees and expense ratios
When a company decides to offer a retirement plan, there’s a cost to set up and administer it. You can’t avoid the fees to run the plan, although if you notice that your company seems to be paying a higher-than-normal percentage for plan administration, you may suggest they look at alternatives.
When you choose your investment options you will have a direct impact on the fees you pay. Many plans offer index funds that charge less than 0.05% and managed funds that may charge 1% or more. This may not sound like such a big deal, but it can add up over time. According to a NerdWallet article, Say you’ve invested $100,000 at a 7% annual return: A fund with a 0.80% expense ratio could eat up $70,000 more of your returns over 30 years than a fund with a 0.40% expense ratio.
The key is to minimize fees while achieving the investment results you need to provide for a comfortable retirement. Some people invest only in index funds while others may choose actively managed funds or a combination. Look closely at the fees along with past returns (knowing that past returns are just that – in the past) when making your decision.
Note: watch sneaky fees. When I was reading through my wife’s brochure, I saw there was an option for a self-directed brokerage account. I was curious, having never seen that before in a retirement plan. Once I read a little about it though, I saw the $50 per year administrative fee for this option. While this may be appropriate for some participants in the plan, we decided the fee was too high since we already have an online brokerage account.
Beware the default investment
When you first invest in your retirement plan, most companies will place your money into a default fund. Some use a money market fund that preserves your principal while others will push you into the target date fund that most closely corresponds to your age (in other words, if you’re investing this year – 2022 – and are 25, that means you’ll reach full retirement when you’re 67 in 2064, so you would probably be invested in the target date 2065 fund).
If the default option doesn’t align with your goals, it’s on you to change your investments. And there are two changes you must make. You will need to change your current investments (that is the pot of money already in the retirement plan) and your future investments (contributions you make through your upcoming paychecks).
Don’t put this off
My youngest started college this year. I swear he was 7 years old just a couple of years ago. Time flies. It’s easy to say I’ll do this tomorrow, or I’ll do this when I have more time. Do yourself a favor and do it now. If you don’t feel confident making the decision on your own, go onto different websites and find asset allocation models that fit your goals and risk tolerance, then use them. Talk to friends, go to retirement plan meetings at work. But start investing for retirement now. You’ll thank yourself later.
Photo by Antoni Shkraba