Dear Liz: With all the investment options offered in 401(k) plans, how as a contributor do I know where to place my money?
Answer: Too many investment options can confuse contributors and lower participation rates, according to a study by social psychologist Sheena Iyengar of Columbia University in cooperation with the Vanguard Center for Retirement Research. The more options, the more likely participants are to simply divide their money evenly among the choices, according to another study published in the Journal of Marketing Research. That’s a pretty random method of asset allocation and one that may not get people to their retirement goals.
As a participant, you want a low-cost, properly diversified portfolio of investments. For most people, that means a heavy weighting toward stock funds, including at least a dab of international stocks. Your human resources department or the investment company running the plan may be able to help with asset allocation.
Some plans offer free access to sophisticated software from Financial Engines or Morningstar that can help you pick among your available options. Once you have your target asset allocation, you’ll need to rebalance your portfolio, or return it to its original allocation, at least once a year. A good year for stocks could mean your portfolio is too heavily weighted with them, while a bad year means you need to stock up.
If that feels like too much work, you may have simpler options. Many plans provide a balanced fund, typically invested 60% in stocks and 40% in bonds, that provides automatic reallocation. The same is true for target-date funds, which are an increasingly popular choice. Pick the one with the date closest to your expected retirement year. If you’re 35, for example, you might opt for the Retirement 2045 fund.
It’s important, though, that you minimize costs because funds with high fees can leave you with significantly less money at retirement. The average target-date fund charged 0.73% last year. If you’re paying much more than that, and have access in your plan to lower-cost stock and bond funds, choose those instead.