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Anyone who's seen a menu of funds provided by their HR department knows how confusing and overwhelming they can be. You open your 401(k) plan and see hundreds of mutual funds, with names you don’t understand, paired with all sorts of seemingly random numbers. Even worse, the funds are often not organized in any useful way, and their names are typically incomprehensible to the untrained eye. Data on available funds is predominantly led by recent investment performance, while you'll have to go digging to find the expense ratio. Furthermore, there are an overwhelming number of options, ranging from basic to extremely esoteric. The latter leading people to invest in places they don't understand. It’s like walking into that diner that sports an eight-page menu, you thought you were hungry for a burger but after flipping through that thing, you’re exhausted and now unsure if you’re even hungry.
Where do I start?
The best advice is to keep things simple. Don’t try to get cute, it’s completely okay if you invest in one fund or even just a few. You don’t need to be invested in 30 different funds, some of which you may or may not understand. If you do want to do it yourself, your employer-sponsored plan should have at least one way to properly invest without stepping on a land mine.
If you can, find the handful of broad-market, low-cost, index funds for the two main asset classes: stocks and bonds. The key is to not get distracted by fancy names and recent performances. Hone in on the easy-to-understand funds, and use their simplicity to your advantage. Having a few simple funds makes it easier to rebalance your portfolio regularly and get your asset allocation back on target after market fluctuations.
If rebalancing sounds like a chore to you, target-date funds can be a one-stop-shop, but only if you use them correctly and fully understand the underlying asset allocation of the fund you choose and how it will change over time.
How Can I Identify Broad Market Index Funds?
The easiest way to do this is by looking at the name of the fund. The Names Rule requires that the fund invest at least 80% of their assets in the investment type, industry, and geographic location their name suggests. In other words, funds are required to put in their name plain language that can help investors to understand what the fund does at a high level. For example, look for the funds that have “index” directly in the name, or “Broad Market Index” or “S&P 500 Index”, just to name a few examples. These funds track the index the name suggests so they are easy to understand and typically have very low expense ratios, they are very cheap to own.
Where Can I Find Help?
If you’re feeling overwhelmed, you’re not alone. Managing a 401(k) can be complicated and overwhelming. If you’ve tried the strategies outlined above and are still feel uncomfortable, you have some options that may help you lower your anxiety.
When you eventually leave your job, you have the right to rollover your account (e.g. 401(k), 403(b), 401(a), 457) from your employer's plan into an IRA, expanding your investment options and giving you much more flexibility. Some retirement plans even let you rollover assets while you're still on the job. Since the building blocks aren't restricted to a particular menu, you’ll have more options to build a more tailored approach. If the thought of opening the floodgates of investment options adds to your anxiety, this rollover also opens the door for you to work with a financial advisor who can help you manage your discomfort and build a strong portfolio, personalized to your goals.
Other plans, such as at our nearby University of Michigan, will let you work with an investment advisory firm to manage your retirement plan directly, while you’re still employed. You’ll still have to choose from the preset menu, but you can have help choosing the most appropriate investments for you and your financial plan.
So, in the case of an employer-sponsored plan, is it possible to order off a limited menu and still manage to build a quality portfolio? With the right mindset and research tools, yes! Depending on the particular menu and your specific needs, start with low-cost index funds and bolster with additional funds if needed. Remember to keep it simple. If you find yourself staring at your investment menu still feeling completely overwhelmed, consider using one of your lifelines.
Matt Farris, is a Portfolio Manager at Exchange Capital Management. The opinions expressed in this article are his own.
