Before entering your employer’s 401K plan, you need to decide:
- Percent of pre-tax contributions
- Percent of post-tax contributions
- Percent of employer match
At the very minimum you want to contribute whatever % your employer matches, this way you can get the $ that your employer sets aside for your 401K.
Preferably you will maximize % of pre- and post-tax contributions regardless of employer match.
Percent of pre-tax contributions are useful for reducing your AGI (adjusted gross income). Percent of post-tax contributions are useful for building up your retirement nest egg in a way that is automated (out of sight, out of mind, therefore out of impulsive spending if you have those habits).
The only time when you may consider reducing (never eliminating!) your pre-tax contributions is when you have a significant loan term that has a less favorable % return than if you take that percent of your paycheck to pay down the loan. Even then, calculate carefully whether your investment returns in your 401K may fare better. Example: you have a mortgage loan at 6%. You may calculate the probability that you’d do better paying this down sooner versus building up a nest egg 401K that compounds interest over time.
Part of the investment election process includes:
- Choice of funds
- Expense ratios (cost)
- Redemption fees
- Your investment plan or strategy
Employers often offer both passive index (mutual) funds AND actively managed funds. Employees are able to choose what products they want their contribution to go toward.
Basically the options are in broad categories of “Bonds, Stocks/equities, and Target Retirement”.
Bond funds are just that — made of bond products, although you’d want to look at what are actually in those bond products. Sometimes these include treasury (US dollars) and other mortgage backed securities, some of these riskier than others.
Stock funds are made up of all or selection of stocks in the stock market that is supposed to represent “the market”.
Target retirement funds tend to be actively managed (more expensive) but is promoted as “you don’t have to do anything, we’ll do it for you” products. These are sometimes called Life cycle fund or similar name. It’s supposed to shift the allocation of lower-risk (usually bonds & cash) versus higher-risk (usually stocks) products as you age, so that you won’t be exposed to too much risk as you near retirement age. I don’t buy these since I can click buttons and enter % of allocation for bonds:stocks based on risk tolerance and overall retirement portfolio (important if the household has dual working partners so you are dealing with 2 retirement portfolios not one).
My rule is to ALWAYS GO FOR PASSIVE INDICES. In other words, products that are a version of “S&P500 index”, “Total stock market index”, “Total bond market index”, “Total international stock market index”, and “Russell 2000 index”. This is because the cost of owning these (expense ratio) makes a huge difference over time as you leverage compounding interest, without paying the 401K management company a higher cost to buy other funds. In 401K these actively managed funds tend to be ‘sector based’, such as ‘healthcare’ or ‘technology’. I ignore those, since I can buy sector mutual or ETF funds for way cheaper at Vanguard’s retirement account.
‘s an example of a Russell 2000 index fund expense ratio (cost) at a major employer’s 401K fund selection:
Same employer’s sector-based (science/tech) actively managed fund:
Granted, the “Morning Star” boxes are not identical because the science/tech fund is more Large Cap-Growth (big companies) while Russell 2000 focuses on smaller companies (high risk and high reward Small Cap-Blend), but if you want to focus on big companies then you might as well go for the total stock market index fund (cheaper Large Cap-Blend) which costs:
Finally, investment strategy is based on where you want your money contributed when it is automatically entered into your 401K account, and how often you want to move your money based on market conditions (although you will never move it while incurring any redemption/short-term trading) fees. Moving money isn’t taking it out (distribution — a No-No) — it’s simply transferring monies in a particular fund into another particular fund to match your (“household”/family) overall portfolio’s target asset allocation.
For example, if the S&P index fund has done well but is looking over priced, I will move all/a percent of money out of this into another fund that is pulling back (looks cheaper). Usually I have enough time to plan because I can’t move money between accounts without incurring redemption fees, so I may start watching a particular index that appears to be heading to lower prices and wait until I can “sell high” (fund that’s doing well and moving money out of” to “buy low” (fund that’s cheaper).
Disclaimer: Not a CPA, not a Financial Advisor, Not affiliated with FINRA. Just an individual who has taken time to educate myself on money management and I usually read Prospectus(es).