How To Choose The Best Investment Options In Your 401(k) Plan – Forbes

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One of the most important financial decisions you are ever going to make is how to invest your 401(k). Last week, I recommended 17 mutual funds whose managers have proven themselves over the past decade by outperforming the market by a wide enough margin to make a difference for investors. But what if your 401(k) plan does not offer any great fund managers? Here’s what you can do.

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Open A Brokerage Window

There are lots of mutual fund managers in training who are as yet unproven. You should let them train with other people’s money, not yours. Instead of paying an unproven manager to train with your money, ask whether your plan provides a brokerage window.

Roughly 40% of 401(k) plans will allow you to set up a brokerage window through which you could invest in a wide array of stocks, bonds, exchange traded funds (ETFs) and mutual funds that are normally not available. However, only about 3% to 4% of those with access to a brokerage window use it. If your plan does not offer any of the 17 mutual funds, you may still be able to invest in them through a brokerage window.

Choose An Index Fund

If your plan doesn’t offer any great fund managers, and you cannot set up a brokerage window, then choose an index fund tied to a broad market index such as the S&P 500.

There is a high probability that the S&P 500 will outperform an unproven manager, so in addition to saving on the management fee you are likely to net yourself a higher return.

Over the long-run, the S&P 500’s return will approximate the growth rate of the economy plus inflation. For planning purposes, estimate a 5% to 7% return over the next 25 years.

If this return is sufficient to fulfill you financial plan, you are in good shape if you stick with the S&P 500 index fund through thick and thin.

If a 5% to 7% return is not enough, consider an index fund tied to a small-cap index such as the Russell 2000. Small-cap stocks have historically outperformed large-caps but are more volatile. If you choose this option, be sure you have a long time horizon so that the ups and downs average themselves out so you have the best chance possible of gaining the additional 1% to 2% a year that small caps have returned in the past.

Set Up A Rollover IRA

When you change employers, take your 401(k) with you. Many employers will let you keep your account in their plan and even offer to pay the annual fees.

If you leave your account with your old employer, you may save $50 a year in fees, but you have to live with their limited investment options. It is far more important to be able to invest in the best managers than it is to save the $50 a year.

When you leave your job, have your 401(k) account transferred into a rollover IRA that gives you access to the best managers.

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If you have 401(k) accounts at more than one previous employer, it can be difficult to gather the data needed to know where you stand as whole. Having your accounts under one roof, under your control, free of arbitrary investment limits is a good first step to making your retirement assets perform better.

This article is part of a series I write for those who invest in mutual funds. To be notified when the next installment is published, click here.

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