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The Retirement Power Hour
The Retirement Power Hour
How Should I Invest my 401(k)?
According to a 2023 SurveyMonkey study, 46% of 401(k) investors don’t know what they’re actually invested in. If that’s you — don’t worry, you’re not alone.
In this episode of The Retirement Power Hour, Joe Allaria, CFP®, breaks down the most common 401(k) investment options and helps you answer one of the most important retirement questions: "How should I invest my 401(k)?"
We’ll cover:
✔️ Target date funds: pros, cons, and how to adjust
✔️ DIY investing: building your mix of large cap, small cap, international, and bond funds
✔️ The truth about high-yield (“junk”) bond funds
✔️ Passive vs. active management inside your 401(k)
✔️ What managed account services really offer
✔️ Hidden fees to watch out for
✔️ When to consider a self-directed brokerage account
✔️ Whether an in-service rollover to an IRA makes sense for you
This is Episode 2 in our 401(k) Series. If you missed Episode 1 "How Much Should You Contribute to Your 401(k)?", be sure to check it out first!
Resources Mentioned in the Show:
The Evolution of Qualified Default Investment Alternatives
Go Global for Diversification that Travels Well
Submit Your Questions To submit a listener question, visit our website, https://www.retirementpowerhourpodcas..., and enter the details of your question.
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Disclaimer: All material discussed on this podcast is for educational purposes only and should not be construed as individual tax, legal, or investment advice. Investing involves risk of loss, and investors should be prepared to bear potential losses. Past performance may not be indicative of future results. Joe Allaria is an Investment Adviser Representative of CarsonAllaria Wealth Management, Ltd., a Registered Investment Advisory firm. The information discussed on this podcast may be derived from third parties that are believed to be reliable, but CarsonAllaria Wealth Management does not control or guarantee the accuracy or timeliness of such information and disclaims all liability for damages resulting from such sources. Any references to third parties are provided as a convenience and do not constitute an endorsement. Learn more about CarsonAllaria Wealth Management at https://carsonallaria.com/
Invest Wiser & Retire Better!
Understanding How to Invest in Your 401(k)
Joe Allaria:According to a 2023 study by SurveyMonkey, almost half of 401 investors are clueless about the investments in their 401. The study revealed that 46% of 401k investors didn't even know what investments were in their 401. And if you don't know the investments in your 401, you probably don't know which ones are the right ones for you. But in today's episode, we are going to break down all the options that are typically available to you in a 401k. And by the end, you will be able to answer the question that many ask: how should I invest my 401?
Joe Allaria:Introduction to the Retirement Power Hour 401(k) Series
Joe Allaria:Welcome everyone to the retirement power hour. My name is Joe Allaria, and this is episode 39. And we are in a series right now around 401ks. This is the second installment in that series. The first video we covered how much should you contribute to your 401. And today we're going to talk about how should you invest in your 401. And the reason we did how much to contribute first is because we believe that's most important. So if you did not watch that video, I would go back and watch that video because even if you have the very best fund in the world, it will not matter if you're not contributing enough to your 401k. So go back and watch that video. But again, today we are going to teach you how you should invest in your 401k.
Joe Allaria:Important Disclaimer: General 401(k) Investment Education
Joe Allaria:We always have to say this is not meant as individual advice. So this is general education. We hope to give you some tools, give you some education today so that you can go and make better decisions with your money. Because keeping in mind, everyone's situation is different.
Joe Allaria:Factors That Influence Your 401(k) Investment Decisions
Joe Allaria:Other factors that would affect your investment decision might be: do you have investments outside of your 401? Does your spouse have investments outside of your 401k? What is your risk tolerance? What are your personal individual goals? When do you plan on retiring? So these are all things that might tweak the recommendations for how to invest in your 401k.
Joe Allaria:Common 401(k) Investment Options Explained
Joe Allaria:So we want to give you some tips, some general rules of thumb, and to explain to you what the common options are inside of your 401k. So let's jump right in and start with what are those typical options that investors have. And so when you log in, many of you have seen this before, I'm sure, but you'll log in to your 401k and many platforms out there, Fidelity, Vanguard, they will give you different options to choose from. And they usually say something to the effect of uh do it myself, do it for me, or help me do it. And so what do those things typically mean? Well, do it myself typically means that you are going to choose your own mix of funds. And we'll talk about that in just a second. Do it for me typically means you are selecting the plan's qualified default investment alternative, also known as the QDIA. What does that mean? Basically, just the plan's default option. If you don't choose your own fund, it has a default option for you. Now, that could mean a target date fund. We'll talk about those. That could mean a managed account service. We'll talk about that as well. But depending on your plan, the plan will decide what your default investment option is. So that's typically what do it for me means. And then the third option, help me do it, generally means that they will give you access to certain tools and give you some guided advice. And once again, it could mean that you are selecting that managed account service where you are going to pay an additional fee to get advice or really to have someone else choose your allocation for you. So we're going to talk through a few of those options as we go through today. And I want to also mention a fourth option that is not as common, but we actually did a video on this around PCRAs, a personal choice retirement account. This is offered through Charles Schwab. That is a Charles Schwab term, but what that is referring to is a self-directed brokerage account. And that is, again, more rare, not as common, but some plans will give you a self-directed brokerage account option. And that's where you can go off script and choose basically any investment you'd like from the entire investment universe. And you can do that off the 401ks platform in many cases. Charles Schwab is one of the main providers of that type of platform. We're not going to talk as much about that today, but that is out there. If you do see that as an option, self-directed brokerage account, I would encourage you to go watch the video that we did on Schwab PCRAs and contact us if you have any questions about that. And on that front, if you have specific questions about how you should invest and you want that question answered for you, or you want more questions answered for your retirement plan, for your investment plan, go to retirement powerhourpodcast.com, retirement powerhourpodcast.com. And you can select work with me. You can schedule a time to have a phone call. You actually have a phone call with me or one of our staff. And we will just have a simple conversation, learn about what questions you have, and start building a path to answer those questions. We offer a free retirement analysis for anyone that reaches out to us. We're going to give you some basic tips and tricks and tell you what track you're on. You know, again, for anyone within five to 10 years of retirement, we highly recommend that. It's a free retirement analysis. So take advantage of it. Again, it's at retirementpowerhour podcast.com. Okay, so jumping in and talking about these three different options, let's start with target date funds. Again, this is the do it for me option.
Joe Allaria:Understanding Target Date Funds in Your 401(k)
Joe Allaria:Target date funds are professionally managed funds that will basically adjust your allocation as you go through your working career, and it will make it essentially more conservative for you as you get closer to retirement. When you're younger, it will invest for you automatically. It will tend to be more aggressive. And this is something that if you want something that is set it and forget it, a target date fund is typically the best option to go. Now it's going to be one fund. And I always share this with people when we're talking about target date funds. That doesn't mean you're putting all your eggs in one basket. It is one fund, but it's a fund that's made up of sometimes multiple other funds, but it's made up of a lot of different types of investments inside that one fund. So you're going to have an allocation to stocks, an allocation to bonds. And again, that's how they're going to determine how aggressive or conservative you're going to be in that fund. And they're often labeled by the year that you are projected to retire, or they're labeled in increments of five years. They'll choose the one for you that's closest to when you'll turn 65. So, for example, you might see target retirement fund 2035. That would say that around 2035, you'll be hitting 65 years of age. It's going to see your age. It's going to anticipate and estimate when you're going to retire. It's going to assume that date is around 65. And as you get closer to that date, it's going to be more conservative and more conservative the closer you get to that point. So that's a target date fund. You can put your money in, it's one fund. You don't have to worry about rebalancing. You don't have to worry about making changes. If all you did was select a target date fund today and you're 25 years old and you did nothing until 65, it's going to do a decent job, in my opinion, of making you more aggressive now and dialing that back as you get closer to retirement.
Joe Allaria:Pros and Cons of Target Date Funds
Joe Allaria:Now, some people in our industry, for whatever reason, they don't like target date funds. They don't think target date funds are a very good option. I disagree, and the proof is in the pudding. Target date funds represent the QDIA for 98% of retirement plans out there, according to Vanguard. And we'll put a link in our resources and in the notes. But target date funds represent 98% of the QDIAs for the retirement plans out there. So it seems that most people think they do a pretty good job. I think they do a fairly good job of helping you get to retirement or close to retirement. Now, where they fall short is once you retire, or maybe even when you're within five years of retirement. That's when you're going to want a higher bond allocation. You're going to want some more customization. And really, you need a customized retirement plan at that point, in my opinion. So I don't think a target date fund or any other service for that matter is going to do a great job when you're that close to retirement because the right allocation is going to be largely dependent on the input from you and your situation. It's going to take a lot of engagement from you. And a target date fund just doesn't require that. And even these super turbocharged target date funds out there that have more lanes you can go into, they require more input from you. And it's trying to get you in a better position. But I think the best result, the best option for you is to get a customized retirement plan and work with a retirement advisor to figure out what your allocation should be when you're within five to 10 years of retirement. If you are 15 years, 20 years from retirement, again, I think a target date fund typically does a pretty good job. And there are ways to adjust your risk tolerance, and that's a big criticism of target date funds. If you're a scheduled for a 2040 target date fund, you can look at the allocation. A 2040 target date fund, that's about 15 years from now. Hypothetically, let's just say that's about a 65% stock allocation or a 70% stock allocation. Maybe you want to be 80 or 85. Well, what you can do is instead of using the 2040 fund, use the 2050 fund or the 2045 target date fund. You can see what the allocation is. If you want to be a little bit more aggressive, you can just bump that target date fund back five years or 10 years. If you want to be more conservative, you can bump it up five years. So you can make adjustments there pretty easily by just changing the target date fund that you use and without overthinking it and thinking that we need some different type of i nvestment.
Joe Allaria:Fees and Performance of Target Date Funds
Joe Allaria:So one point of caution on target date funds, like with any investment, you just need to make sure the fees are reasonable. And you know, again, a lot of target date funds that I see out there have very reasonable fees. So some of the criticisms I've heard around target date funds, I don't really think are well founded. I think they do a pretty good job. I think they're great for beginners. I think if you're someone who doesn't want to log into your 401k every day or once a month or once a quarter, this set it and forget it type of strategy could be very, very good for you. And it's very easy to set up. So, next, let's talk about choosing your own investments. Typically, when you go to choose your own investments, again, you're gonna want to pick a handful of funds to give you that nice diversification. The target date gives you that instantly with one fund, but you're gonna want to try to build that out with uh different sectors of the market.
Joe Allaria:Choosing Your Own 401(k) Investments
Joe Allaria:A lot of the options you'll see commonly large cap, mid-cap, small cap, US, international, uh, bond funds, maybe stable value or money markets. You'll have to piece these together with a mix that is right for you. So this is gonna require a greater knowledge of how you should be allocated, how much should you have in large cap or mid-cap or small cap. So I just want to give you a couple points on each of those categories. When you see, first of all, large, mid, and small, those are typically referring to US funds. So we're just talking about domestic funds. And according to Dimensional, the United States makes up about 65% of the world's market capitalization. So US-based companies make up 65% of the world market capitalization. So if you're trying to mimic the total market cap of the world, you may want to look at having 65% of your mix in US funds. Well, that still leaves 35% that are non-US, right? And if you want to have some bond funds in there, well, then you've got to make that adjustment as well. But if you're going 100% stocks, if you wanted to match the world market cap, the number would be about 65% within the US allocation. Again, you have large, mid, and small. If you want diversification, you'd want to use all three of those sectors. And it wouldn't be evenly to match the world market capitalization. Uh, most of that is coming from large cap, about 70% is coming from large cap and then mid-cap and then small cap. So there's no right allocation, but what I'm referring to is the world market capitalization. If you said, I just want to invest in the market, well, technically it's that's not the S P 500. That's every company in the world, US, international, large, mid, and small. If US-based companies make up 65% of the market, that means international companies make up 35%. Often something that is lacking in people's portfolios are non-US related investments. So that's something to think about. And then unfortunately, you know, there's something I refer to as the bond trap often gets investors inside of 401ks. And there's really a couple traps I'm talking about. When you look at how many options you have inside of fixed income or bond funds, a lot of times you're only looking at two, three options, not many options. And again, a lot of times you are looking at index style bond funds, which are either passive or active. And passive just means you are investing in the index. You're trying to invest in all the companies in that sector. Active means you have someone professionally managing, picking which companies to include and which companies to exclude. Now, in the stock space, a lot of times index funds do very well. Passive management does very well. In the bond space, what we have found is that you can get a lot of benefits from actively traded bonds and bond funds. So that is a drawback because you don't have access a lot of times to actively manage bond funds inside of 401. Another trap I see inside of 401ks is investors will sometimes look in the bond section and they'll see high yield bond funds. And they'll think I need to add some bond funds because I don't want to be 100% stocks. Someone closer to retirement might think I want to be 6040, 60% stocks, 40% bonds. They'll see high yield bond funds. And that sounds great. It sounds like a very positive thing. They'll oftentimes see returns that look higher than some of the other options in the bond fund category. So they'll select high yield bond funds.
Joe Allaria:Avoiding the “Bond Trap” in Your 401(k)
Joe Allaria:But what that actually means, another word for high yield bond fund is junk bonds. And what they are, they're they're lowly rated bond funds, which means they're high risk. So instead of high yield, you could say high risk bond funds. And that generally leads to more volatility. When stocks are going up and down, they're when they're going down, having volatile periods, you're gonna see those high yield bond funds almost act like stocks more than bonds. So it's important to understand if you want more safety and less fluctuation, then you don't want to choose high yield bond funds. So something to keep in mind when you're looking at stocks and bonds. So a couple other things to think about if you're trying to choose your own investment mix, you need to think about rebalancing. You know, what you pick for today, is that still going to be right next year or the year after that, or five years down the road? Because again, we're not talking about a target date fund that does it for you here. Now you have to do it. Now you have to monitor and make sure your stock to bond allocation is the way you want. And it is showing the right percentages based on your risk tolerance. You need to look at fees of every single fund in that mix of funds that you've chosen. And you also need to be aware that funds can be swapped out, removed, replaced. You don't have any control over that. But if it happens and it affects one of the funds that you've chosen, you need to be on top of that because sometimes we don't have an apples to apples replacement option for some of the funds that are replaced in 401k. So what your 401k provider might do is they might remove a large cap lend and they might add a large cap value fund as a replacement. Well, those aren't the same. So you need to understand that as well. And lastly, I want to talk about using a managed account service, and that's oftentimes it could be your qualified default investment alternative. It could say help me do it. But the the important thing to note here is that unlike a target date fund, which they do have fees associated with target date funds, this is often an additional fee. And this is often a greater fee. A lot of times you could pay a half of a percent for an advisor to invest for you on your behalf. But I would just really caution 401k investors in choosing this and understanding what this means before you go this route. So, first of all, I'm not saying it's a bad option, but you need to understand what you are getting for the fee. Are you getting additional financial planning? Are you getting additional retirement advice? Or is someone simply selecting funds on your behalf? And most often, that's a that's exactly what's happening. Someone is just selecting a mix of funds on your behalf. And the reason I have such a problem with that in many cases is sometimes people don't even know they've signed up for this service, and then they're paying a fee and they've not been contacted or they haven't spoken to any advisor or any representative that is licensed who can help them build out the allocation that's right for them. Maybe you filled out a questionnaire, maybe you filled out a risk survey. But, you know, at the end of the day, people are more than just questionnaires and surveys. So if you fill out a survey, that's gonna inform me on how to invest for you. But as an advisor, if I'm doing my job, that's not going to tell me everything I need to know to invest for you. And that's exactly what's happening with these big platforms. People are paying fees. They're not talking with an advisor or their advisor or anyone who knows anything about their situation, and they're paying half of a percent to get this uh extra service that they think is you know in their best interest. When all the while, you know, for those type of people, if you're not talking to anybody, I believe a target date fund is probably just as suitable. Again, speak with an advisor yourself, um, do the research, but just be aware that the extra half of a percent for no additional service and for someone who doesn't know you to pick an allocation for you. To me, I don't think that makes a whole heck of a lot of sense.
Joe Allaria:When Paying for 401(k) Management Might Make Sense
Joe Allaria:But there are situations where paying extra for someone to manage your money does make sense. I said earlier, as you get closer to retirement, you want a full retirement analysis, a full retirement plan. You want more customization, your spouse has investment assets, maybe one of you has a pension, you're thinking about Social Security. These are all things that should inform your allocation. So someone needs to look at these things. I can't just look at one account and you've got other accounts out there and just look at one account and give you the right allocation for you, knowing nothing about your situation. So I need all of the information and I need to compile that together, and that's going to lead to the best advice in terms of how should your 401k be invested. And maybe you don't want that weight because maybe the balance is high. A lot of times, you know, if you get over $500,000, you just may want someone else to do it for you. The balance is getting large at that point. Again, or if you're close to retirement, that makes a lot of sense. If they're giving you a good product, you know, as part of that service. Now you may need to go outside of your 401 to get that service. Some plans will allow something called an in-service withdrawal. And you might want to write this down an in-service rollover.
Joe Allaria:Using an In-Service Rollover for More Flexibility
Joe Allaria:This is when you're still working, but in a lot of cases you're over 59 and a half, and you want to get those additional services, retirement planning, tax help, investment help, social security help, all that. You want to build a customized plan for you, but they don't offer that in your 401. So if you have that in-service rollover option, you can do that, roll your money from your 401k to an IRA while you're still working. No taxes, you know, no penalties to do that. And now you can get those additional services. You can get the discretionary investment management service as well. And you know, you will pay an additional fee for that when you work with an advisor to do that. But at least you're getting the services that you want to get. So beware of the extra fee for no service. But there are cases that you may want to look into paying the extra fee for those additional services. So, once again, if that's you, go to retirement powerhour podcast.com and click work with me. You can get a retirement analysis. It's free, it doesn't cost you anything. We can uh show you, answer a couple of your questions, show you what track you're on, help you reduce taxes, you know, help you uh set up your estate so that your money goes where you want it to go at the end of life and get you in the right allocation uh today and for the future. So go to retirement powerhourpodcast.com, click work with me, and that's where you can do that.
Joe Allaria:Upcoming 401(k) Topics in This Series
Joe Allaria:You can also submit questions on retirement powerhour podcast.com. We're happy to answer those as they come in. You can answer those on a future show. Go back and watch episode one of this series if you haven't seen it, and stick with us. We're gonna continue to do additional episodes in this 401k series. We've talked about how much to contribute, how to invest. We're gonna talk about more important topics, how to get money out of the 401k. What are some traps that you want to avoid in these 401ks? So stay tuned for more videos in this series. I want to thank you for watching this episode of Retirement Power Hour, where we help listeners invest wiser and retire better. Take care.
Speaker:Thank you for listening to the Retirement Power Hour Podcast. All material discussed on this podcast is for educational purposes only and should not be construed as individual tax, legal, or investment advice. Investing involves risk of loss, and investors should be prepared to bear potential losses. Past performance may not be indicative of future results. Joe Allaria is an investment advisor representative of Carson Allaria Wealth Management, a registered investment advisory firm. Information discussed on this podcast may be derived from third parties that are believed to be reliable, but Carson Allaria Wealth Management does not control or guarantee the accuracy or timeliness of such information and disclaims all liability for damages resulting from such sources. Any references to third parties are provided as a convenience and do not constitute an endorsement.
