How to Invest Your 401(k)
Considerations For What Funds To Choose And How Much To Invest
For many people, deciding what funds to invest in and how much to contribute from their paycheck into their 401(k) plan can be confusing.
According to the 401K Help Center, an Oregon-based financial knowledge center that monitors and aggregates industry updates and information on 401(k)s, there are generally eight to 25 investment options within a plan, with 19 choices on average. So how do you know what to invest in, and how much?
“You generally cannot invest in individual stocks unless it’s the company stock,” states CFP® Dustin Obhas, financial adviser with CLA Financial Advisors, in a June 2016 article for Market Watch. Obhas recommends that an appropriate fund instead should be a mix of both stocks and bonds within exchange-traded funds or mutual funds.
What to consider in planning your 401(k) investments
There are two major points to consider when deciding how you invest in your 401(k): how much money you’ll need, and how many years until you plan to retire. You’ll want to find out whether your employer offers a contribution-match percent — typically 50 cents on the dollar for the first 6 percent you save — so you can take full advantage in increasing your capital gains.
Also, consider your risk levels and the investment expenses or expense ratio of the fund, as this information will better help you determine whether investing in ETFs or mutual funds is the way to go.
Mutual funds versus exchange-traded funds
Both mutual funds and ETFs are a compilation of stocks, bonds and securities, and are managed professionally. ETFs are considered a better alternative; their many pros include their transparency, flexibility and low cost. CFA Donald Bennyhoff, a senior investment analyst for Vanguard Investment Strategy Group, highlights the differences between ETFs and mutual funds in an article for Vanguard Investment Counseling and Research:
- In general, ETFs cost less than mutual funds because they do not need to be actively managed by a professional and thus they have fewer operational and marketing costs. With ETFs, the portfolio tracks a specific index, like the S&P 500, rather than the performance of individual bonds and stocks.
- You can get a more accurate read on the value of the fund throughout the trading day and with real-time settings, whereas mutual fund shares are priced at the end of the trading day and can be traded only after the net asset value has been determined.
- Trading in ETFs is much more flexible than mutual funds. There are no restrictions, because they are traded on a secondary market like a stock and can be sold short — unlike mutual funds, which do not allow for margin trading.
- There’s no minimum investment for ETFs, while mutual funds require a minimum contribution, making them less accessible if the individual has limited money to invest.
- Individuals investing in ETFs will be taxed on only their own capital gains and personal earnings, whereas with mutual funds, the investor will be taxed for all profitable securities sales.
Mutual funds are still a great option for investing, especially if you have the capital to make more than minimal investments and if you’re closer to retirement. Because mutual funds are actively managed by a professional, your portfolio of investments will be better diversified than ETFs and can bring higher return on investment. The professional will decide which stocks and bonds to invest in to meet your earnings goals based on the individual performance of those securities on a daily basis.
“If an investor buys ETFs at a premium to NAV and sells them at a discount, the investor may earn less than the return of a conventional fund that tracks the same underlying index,” explains Bennyhoff.
In comparison, there are no brokerage fees or bid/ask spreads for mutual funds that could cut into your return on the investment made. Furthermore, mutual funds have comparable options within each asset class for funds that don’t charge on trades, called no-load funds, whereas ETFs always charge a fee per transaction.
A May 2015 article in CNN Money reports that financial planners will typically recommend you invest at least 10 percent of your income each year into a 401(k).
“If you don’t think you can contribute because money is tight, at the very least, try to contribute as much as the company is willing to match,” Obhas explains. After all, free money is free money.
Make sure you also understand your vesting schedule so you can plan your retirement for when your company contribution is 100 percent yours. And remember, you can’t take money out of your 401(k) until you’re at least 59 ½ years old or the money will be subject to income tax plus a 10 percent penalty fee.
If you have any questions on the benefits of ETFs or mutual funds, or you would like guidance in investing your 401(k), let us know and we’ll be happy to help.
Published by Cumberland County Federal Credit Union
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Disclaimer – All content contained in this announcement is for informational purposes only and should not be relied upon to make any financial, accounting, tax, legal or other related decisions. Each person must consider his or her objectives, risk tolerances and level of comfort when making financial decisions and should consult a competent professional advisor prior to making any such decisions. Any opinions expressed through the content in this announcement are the opinions of the particular author only.
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