How to Know if Your 401(k) is Being Invested Properly

Daniel Penzing
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Take a Close Look at Investment Fees

One of the easiest ways to screw up a retirement portfolio is to pile on exorbitant fees. As a percentage of the total assets, fees can really add up over time and eat away at any potential returns.

You can get a ballpark figure on the total fees a 401(k) may be charging you by dividing the expense ratio by the total amount in the plan. If it comes out to less than 0.5%, it’s likely you’re still getting a pretty good deal. But if it’s more than that, it’s time to ask yourself whether the 401(k) plan is really worth it.

One thing you can do to gauge what a competitive price is for your 401(k) plan is to check with your peers. Find out what the investment fees they pay and whether you’re paying a better or worse price for your own plan. You might also run some stats on your own expenses to see if you could find a cheaper 401(k) plan somewhere else.

How Many Investment Choices are Available?

The number of different investment choices you have in your 401(k) depends on the mutual funds offered by your plan. All 401(k)s offer mutual funds as an investment option, either using built-in funds or funds provided by a third-party. Mutual funds are a good option for 401(k) participants because they require a low amount of money to get started. Additionally, mutual funds offer a ton of different investment choices.

The first issue to consider is whether you want to accept the investment options offered to you or whether you want to change them. You can change your investment options by either contributing more money to your retirement plan or by taking your contributions out of retirement plan and investing in some other way. You can change your investment options once each year.

If you’d like to change your investment selections, your only option is to withdraw from your 401(k) and make investments in some other way. You can also bring in investment money from outside your 401(k) and invest that money for your own retirement. Finally, it’s likely that you can change your investment choices simply by depositing more money in your retirement account.

Compare the Investment Choices to Index Funds

In the early days of 401(k) investing, your options were limited to a fixed set of pre-packaged investments. These funds would track the performance of the S&P 500, the Dow Jones Industrial Average, bonds, or bonds that were issued by a specific corporation.

Over the course of time, 401(k) providers have added additional options, including international stocks, options, as well as alternative investments, such as real estate and private equity funds. The problem is, some 401(k) providers still offer investment options that may not be the best investment, or what is called a “proprietary fund.”

While it might seem fine to invest in a fund provided by your employer, it may not always be the best or most prudent decision. These—and any other “proprietary” investment—will cost you more in management fees. Although these fees are not necessarily charged to the employee, they are deducted when calculating the amount of your 401(k) match. The proprietary funds also make it more difficult to shift your investment allocations; they might only let you invest fully in their fund, or might limit the amount you can invest with them.

Verify Your Investment Allocation

One of the most important things you can do to protect your savings from a failing stock market is to invest your 401(k) savings wisely. However, many people fail to follow the first rule of investing – never invest in something that you don’t understand. If you’re not familiar with the lingo used on your 401(k) statements, how can you ever hope to make intelligent investing decisions?

Fortunately, there’s an easy way to determine if your 401(k) investments are being handled by a professional. You can call your 401(k) provider and ask to speak with a financial advisor. (Make sure you’re actually transferred to a live person.) If you’re told that you don’t have any financial advisors, or if you’re given a generic answer, it might be time to find a new 401(k) provider.

Paying attention to your investments will help you prepare for the retirement that you want. Fortunately, most 401(k) providers are required by law to offer a sufficient range of investment options to keep your savings safe. It’s your responsibility to make sure that your investments are being handled properly.

When Your 401(k) isn't Being Invested Properly

The most important thing to consider when making your 401(k) investment decisions is how your investment choices affect your results over time. An investment is too volatile if it is moving up and down in large increments from day to day. For example, let’s say that you bought shares in a new company that has just begun marketing a new product. The supply is limited and the demand is high so if you buy at the beginning, you might see a dramatic increase in the value of your investment. Then over time, the demand level drops, the supply picks up and the price stabilizes, so that you are earning a more predictable return. If you sell based on that initial spike, you’ve missed out on a lot of potential growth.

The question you should always ask yourself is what would happen if you changed your option strategy? Instead of:

  • A) Adding to my existing holdings
  • B) My entire portfolio is in the above-mentioned security, above
  • C) Choosing alternative investment options

Assuming there are no tax considerations:

A) If you want to maximize income (in the form of dividends, interest, and capital gains), opt for B. Your profits will be slightly lower than would result from choosing A, and your income would vary from year to year, but your dividends would be predictable and steady.