How to Invest in Your Employer’s Retirement Plan

April 27, 2017

Last week, I wrote about how to invest in a Roth IRA but how about your employer’s retirement plan like a 401(k) or 403(b)? After all, that’s where most people have the bulk of their retirement savings. Here are some options:

Keep it simple…real simple. If you have a target date retirement fund in your plan, this is the simplest option. In fact, it’s probably the default so you may not need to do anything at all.

The idea is to pick the fund with the target date closes to when you think you’ll retire. Each fund is fully-diversified to be a one-stop shop that automatically becomes more conservative as you get closer to retirement so you can set it and forget it. It doesn’t get much easier than that.

There are a couple of downsides though. First, you may not even have this option in your plan. Second, your plan’s target date funds may have high fees. Finally, you don’t have the ability to customize the mix of investments to match your particular risk tolerance (although you can pick an earlier date if you want to be more conservative or a later date if you want to be more aggressive) or to complement any outside investments you may have.

Target a particular risk level. If you don’t have a target date fund or want something more tailored to your particular risk tolerance, see if your plan has a target risk fund or an advice program. A target risk fund is fully diversified to be a one-stop shop, but it stays at a particular risk level so you may want to switch to something more conservative as you get closer to retirement.

An online advice program can recommend a particular mix of investments based on your risk tolerance. Many programs will even use the lowest cost options in your plan and/or factor in any outside assets you may have. For example, if you have a lot of stocks in a Roth IRA, the program may reduce your stock holdings in your plan accordingly. However, it will need to be periodically updated as your situation changes and some programs charge additional fees.

Create your own mix. If the above options aren’t available to you or if you prefer to have more control, you may have to create your own mix of investments. You can take a risk tolerance quiz like this one and use the suggested allocations as guidelines.

Just be sure to look for low cost fund options to implement your portfolio. You may want to use your plan for those assets in which you have low cost fund options and use outside accounts for the rest. (That’s why I invest mine all in a low cost S&P 500 index fund.) Don’t forget that taxes are another cost. If you have investments in taxable accounts, you may want to prioritize the most tax-inefficient investments like taxable bonds, commodities, real estate investment trusts, and funds with high dividends and turnover for your tax-sheltered retirement account since more of their earnings will otherwise be lost to Uncle Sam.

Consider a small amount in company stock. If company stock is an option, you might want to keep a small amount there to benefit from potentially lower taxes on the gains when you eventually withdraw it from the plan. Just don’t have more than 10-15% there because having too much in any one stock is too risky, no matter how great the company is. This is especially true with employer stock because if something happens to your company, you could be out of a job at the same time as your portfolio is decimated.

Not sure what to do? Don’t let analysis paralysis prevent you from investing at all. You can start with a simple option like a target date or target risk fund for now and adjust later. You don’t want to make the perfect investment plan the enemy of the good.