How To Choose Your 401(k) Funds

how to choose 401k funds

How To Choose Your 401(k) Funds

Picking your 401(k) funds can be a daunting task no matter whether you’ve just started a new job or you’ve finally decided to start investing in your company’s 401(k). While the range of funds you’ll have to choose from vary from company to company and 401(k) plan to 401(k) plan, there are many factors you must consider when making your decision.

Investing for retirement is super important, so it’s just as important that you pick the correct funds to invest in. How to choose the right 401(k) funds for you? Here are some things to consider.

What Is My Risk Tolerance?

Risk tolerance is a huge factor you must consider when choosing your 401(k) funds. Risk tolerance is your ability to handle big swings in the market (mainly down swings) without selling.

If you’re super risk tolerant, you probably didn’t sell when some investments went down 50% in the recent “Great Recession”. However, if you sold as soon as your investments went down 10%, you’d have a fairly low risk tolerance.

So why does risk tolerance matter? You want to make sure you’re invested in assets that fit your risk tolerance so you don’t panic and sell when markets go down, as they always do at some point. People with higher risk tolerance will be able to invest more aggressively with their money weighted toward riskier investments that have higher potential returns, while people with lower risk tolerances should invest in less volatile investments that don’t have swings that are as drastic but have lower upside.

Keep in mind, the lower your risk tolerance the more you’ll likely have to invest to reach your investing goals. Why? Investments for those with lower risk tolerance generally have smaller potential positive returns as a result.

When Do I Plan To Retire?

When you plan to retire plays a huge part in which funds you pick in your 401(k). The longer your time horizon is, the more aggressive you can theoretically invest since you’ll have more time to recover from any potential losses you may incur early on.

However, if you’re close to retirement, chances are you don’t want to risk losing a big chunk of your hard earned money right before you retire. That would essentially force you to work longer.

Do I Want To Invest Actively Or Passively?

Many 401(k)s have both active and passive investments to choose from. Active investments are generally managed by a person trying to make you as much money as possible while following the guidelines of the fund. They buy and sell investments in order to try to beat the market but they could easily lag the market, too.

The down side is these funds normally cost more money to invest in. After fees, it has been shown that most actively managed funds don’t beat the market in any given year, so you may want to invest more passively in funds called index funds.

Index funds have a goal of matching the returns of whatever market, or index, the fund is trying to match. The fees are generally much lower in these passive investments and you’ll generally earn a return pretty close to the index the fund is designed to follow.

Figuring Out Which Funds Match Your Needs

Now that you have an idea of if you’d like to invest more aggressively or more conservatively, it’s time to figure out which funds meet your investment goals in your 401(k).

You should have information available to you in each fund’s prospectus that will share whether the fund is a more aggressive or a more conservative investment. Read through these documents and find the funds that meets your needs.

Then, put together a diversified portfolio of investments within your 401(k) that matches your investing goals. It will take a bit of time to research your investment choices, but it will be some of the best time you’ll ever spend.

Don’t Forget! How Much Do These Funds Charge Me In Fees?

One last thing you should always check is the fees you’ll pay for your investments. The best tool I’ve seen to investigate your 401(k) fees is FeeX. So make sure to check out the amazing FeeX tool to see what fees you’ll incur with the investments you have in your 401(k). Fees can make a HUGE difference in your nest egg size when you retire, so make sure you understand their true impact!

Lance Cothern
Lance Cothern loves everything personal finance and has his own blog exploring his thoughts on the subject at Together with his wife, they've paid of over $80,000 in student loans on their way to financial success! In addition to his blog, you can connect with him on TwitterFacebookPinterest or Google+.