How to invest your 401(k) and what to do if it's still in cash

Disclaimer: This is not personalized investment advice - talk with me if you would like some!

You just started your first job. You have the login to your account portal. You set up your 401(k) contributions so you’re at least getting your employer match. Amazing, that’s a great first step! You’re all set now, right?! Well, not quite.

That 401(k) (or other retirement account) is just the tax-advantaged container for your money - but you haven’t actually invested your money yet. But what’s next? How do you decide what do you invest in?

(Psst! For a background on investing, read this investing 101 article before continuing - you’ll get more out of what follows!)

Here’s what to not invest in (inside your retirement account) - cash. If you’re a twenty- or thirty-something and you’re decades away from retirement, you have plenty of time to recover from any market dip and one of the worst things you could do is leave your retirement account sitting in cash. Cash will not only not even try to grow for you, cash will actively lose to inflation over time and you won’t be able to purchase as much with the same amount of money in the future. (Inflation is the general increase in prices over time, and it’s the reason why a gallon of milk today costs $2.99-$3.99 instead of $0.10.)

What to not invest in: cash.

There are of course a lot of other investment choices. When you’re selecting one, make sure you apply that choice to both the money already in your retirement account and future contributions. Those future contributions are what will add up over time and you don’t want to miss those!

Make sure you invest money both that already exists in your retirement account and future contributions.

Now about the choices. You should be able to find a list of all the investment options available to you inside your 401(k) account portal. They will be listed by group type, also known as asset class. You can filter to review each fund’s prices, or ‘expense ratios’, in that list as well. The expense ratio of a fund is one of the most important factors for whether or not you should invest in that fund. Past performance is not even close to as important, because as the funds say themselves, past performance is not indicative of future results.

The expense ratio is the price you are paying to invest your money in that fund.

The expense ratio is the price you are paying to invest your money in that fund. It’s generally quoted as a percent of the money invested. Don’t let the small number fool you though - a 0.80% or 1% expense ratio is very expensive! If you leave your money invested there for any length of time, regardless of whether the market goes up or down, that 1% is being withdrawn from your account each year. Over the 30 years or more that your money will be in that 401(k), that 1% will really add up and impact your returns drastically. Of course, 1% of $1,000 invested is just a $10 fee for the year. However, 1% of $100,000 is a $1,000 annual fee -- and that money is taken out in fees year after year after year, growing as your invested money grows. If you need more reason to choose an inexpensive fund, check out this bulletin from the SEC itself and another from NerdWallet.

Ok, so no cash, and nothing too expensive. But what? Well, it varies and depends on a number of factors, including who you are and what you’re looking for. For the least amount of hands-on management by you, a target date retirement fund is probably the easiest option and can be a great idea to get started. This fund is meant to be an all-in-one fund to keep your investments as simple as possible. It holds a diversified mix of investments: generally across US stocks, international stocks, US bonds, and international bonds. The target date fund will adjust this mix automatically as you near the target date on the fund (e.g. 2045, 2050, 2060) so that it remains appropriate for your personal retirement time horizon. If you’re just getting started and not sure what to invest in within your retirement account, this option could make sense.

A target date retirement fund is probably the easiest option and can be a great idea to get started.

You can also invest in the funds that the target date retirement fund holds on your own by just buying those funds in similar proportions. If you do this, you want to make sure that you rebalance the proportions at least once per year. If stocks appreciate by much more than bonds (and they often do), you’ll want to sell some of the stock funds during that annual rebalance to bring the proportions back into the desired ratio. Doing this on a schedule such as annually will give you the best chance of optimizing your investments!

Alright, you’re there. You not only have your 401(k) account, have logged in to your account portal, set up contributions -- you’ve also made sure those contributions are being used to purchase investments appropriate to you. Amazing! That’s a big step to setting up your personal financial success!

Need help choosing what to invest in within your retirement account? Schedule a free intro call here with Sarah today for help selecting what makes sense for you!

Sarah GerberNovember 4, 2020