Buzz
Retirement savings are crucial, and 401(k) plans provide some of the best incentives to help workers prioritize their contributions. But what if your employer’s plan doesn’t offer the investment options you're looking for?
This is the dilemma that Stephen M. has been dealing with. He sent the following message:
Have you written an article on how to invest within your work's 401(k), especially regarding matching contributions? I’m curious about how to navigate and evaluate the available funds in the plan, and create the most diversified portfolio possible given the limited choices.
It’s even more challenging than other types of investing because, in every job I’ve had, the options are limited to about 20 funds, most of which have 1.0 percent expense ratios, and none of them would be my first pick if I had the freedom to choose. Some companies even match with company stock instead of actual shares bought through one’s own investment selections 😵.
I was assisting a friend with her finances, and I noticed that many workplace 401(k) plans automatically sign you up at a contribution rate of 2 to 4 percent, with an annual increase of 1 percent, regardless of your employer’s match percentage.
Additionally, the plan enrolled her in an actively managed target-date fund, which came with a significantly higher expense ratio compared to the other index fund options available within the plan.
In her situation, given that she had significant credit card debt, I realized that the automatic 1 percent yearly increase had pushed her contributions to 6 percent, even though her employer only matched up to 4 percent. Clearly, the best course of action was to reduce it back to 4 percent, matching her employer’s contribution, and use the extra 2 percent to pay down her credit card debt and improve cash flow.
How to Optimize Your 401(k)
You’ve identified one of the key frustrations with workplace 401(k)s: they often come with limited, sometimes expensive, investment options. If you're unhappy with your current plan—especially if you've realized that your expense ratios are too high—it’s smart to contribute at least up to the employer match and then consider investing elsewhere for the rest.
Generally, I recommend contributing at least up to the employer match, then considering a traditional or Roth IRA. However, if your friend is carrying substantial debt (likely with an interest rate of 17 percent or higher), tackling that debt first is far more crucial. As she reduces her debt, she can start exploring her other investment options. If you want to dive deeper into this approach, I’ve outlined the priority order for financial goals.
Regarding your first question, there are many tools available to evaluate the funds your company offers. A simple method is to search a fund’s ticker symbol on Yahoo Finance or Morningstar; this will provide a detailed breakdown of the companies within the fund. You can also visit the company’s website for additional information. For example, if you’re looking at the FUSEX, or Fidelity 500 Index Investor, just enter the ticker on Fidelity’s site for all the details.
Another great tool to use is Brightscope, which allows you to research and analyze your funds. You could also search the fund name plus 'prospectus' to get an overview of its holdings. Your account statement will also list the funds you're invested in. Alternatively, you can check out recommendations from magazines like Kiplinger and compare those with the offerings from your employer.
To target-date, or not to target-date
I’ve discussed the drawbacks of target-date funds before, which you’ve also pointed out—the typically higher expense ratios. While a target date fund isn’t necessarily a bad choice, especially for beginner investors, if cheaper, comparable index options are available, it’s often wiser to choose those. Personally, I’ve found the target-date funds I’ve encountered to be overly conservative, but that’s really about your own risk tolerance. Just keep in mind that selecting your own funds means you’ll need to manage rebalancing and track each fund’s performance and expense ratios, tasks that target-date funds handle for you automatically.
For diversification, a couple of broad market index funds should generally suffice. You might suggest to your friend to try a three-fund portfolio, or at the very least, maintain a mix of domestic stocks, international stocks (which can often be bundled into a ‘total world’ stock fund), and bonds. If you're unsure about the best mix, this asset allocation calculator can help guide you.
If your plan doesn’t provide these types of funds, you’ll need to do your best to recreate it. As Mytour covered earlier, you can combine:
An S&P 500 fund (which tracks 500 of the largest US companies)
A mid-cap index fund (which includes medium-sized companies, filling in the gap left by mid-sized companies missing from the S&P 500)
A small-cap index fund (which includes smaller companies, covering the small companies excluded from the S&P 500)
Your 401(k) should offer at least these options. If it doesn’t, remember that you can contribute up to the employer match and then open an account elsewhere. Here's how that might work:
Contribute just enough to your 401(k) to get the full employer match.
Put any extra savings into an IRA, which provides more flexibility in investment choices.
If you still have funds after maxing out your IRA (check the limits
here
), go ahead and put the remaining money into your 401(k).
If you max out both your 401(k) and your IRA (great job!), you can open a regular taxable investment account. These accounts are also helpful for medium-term goals, since retirement accounts restrict withdrawals until later in life.
Choose the lowest-cost (quality) funds your 401(k) offers, and then make sure to achieve broad diversification through your IRA.
If you’re really dissatisfied with your 401(k) options, it’s worth discussing it with your management or benefits team. They may not take immediate action, but you might not be the only one with concerns (and if you’re part of a union, it’s definitely something to bring to your reps). If your spouse has a better retirement plan, consider allocating more assets to their plan.
Lastly, remember that your 401(k) offers tax advantages that could outweigh the higher costs. This year, you can contribute $19,000 ($25,000 if you’re 50 or older), which is much higher than the IRA’s $6,000 limit. And as Money Magazine points out, you can always transfer your balance into a new, potentially cheaper account when you switch jobs—just as long as you've contributed to it.
