The Four Essential Steps for 401(k) Investments
In this issue:
- Leaving your company: things to consider for your company 401(k) account
- The Four Essential Steps for 401(k) Investments
- How to Determine the Amount to Contribute to Maximize Your Company Match
- Thrift Savings Plan: The Largest Public Sector Workers’ Retirement Savings Plan
- Market overview: Enjoy the season but don’t be complacent
Leaving Your Company: Things to Consider for Your Company 401(k) Account
It’s said that Americans hold an average of 12 jobs over their lifetime. One of the most common questions we encounter is: “What should I do with my 401(k) account from my previous employer?” To address this, we’ve written several articles, including the following:
- What to Do with Your 401(k) When You Leave Your Current Employer?
- Pros and Cons of Rollover from a 401(k) to a Self-Directed IRA
In the following, we try to summarize a few key factors you want to consider:
- Consolidation: Are you looking to combine your retirement savings accounts into one for easier management?
- Is your current employer’s 401(k) plan better than your former one in terms of
- Fees: the funds’ fees can add up quickly.
- Fund choices: does the current plan offer better or enough diversification investment options?
- If you’re considering rolling over your 401(k) to an IRA, it’s important to take fees into account. Large employers often leverage their size to negotiate lower fund expenses, which can be a benefit of staying in their plan. However, in most cases, you can now find ultra-low-cost index ETFs through brokerages for your IRA, offering a cost-effective alternative.
- Legal Protection: 401(k) and other employer-sponsored retirement plans are generally protected from creditors and lawsuits under federal law, whereas IRAs may not offer the same level of protection.
- Borrowing or 401(k) Loan: 401(k) accounts permit you to borrow against your balance through loans (note: availability may vary by company), a feature not offered by IRAs.
- Earlier Withdrawal Without Penalty: Under the IRS’s IRS’Rule of 55, you may be able to withdraw funds from your 401(k) without penalty at age 55. In contrast, with IRAs, you must wait until age 59½ to make penalty-free withdrawals.
- Control Over Your Money: Your employer can change the rules regarding withdrawals, loans, and investment options in a 401(k) plan, so it’s important to be aware of these potential changes. However, with an IRA, you have more control over your investment choices and the terms of withdrawals.
Ultimately, it all depends on your personal circumstances and the specifics of the company involved. However, understanding these factors can be helpful in making informed decisions.
The Four Essential Steps for 401(k) Investments
While it may seem a bit overwhelming at first—especially for young professionals just starting out—investing in a 401(k) involves some basic and straightforward steps to follow. Below are the details from our Four-Step Guide for 401(k) Retirement Investing.
Let’s quickly review the four essential steps:
Step 1: Decide your risk profile and investment time horizon
First, understand your own risk tolerance, investment time horizon (essentially when you will need access to the money), and investment expectations, such as how much you would like to accumulate for your retirement. This will help you determine how much you should allocate to stocks, which is referred to as your risk profile.
Key points to consider
- Stocks are significantly more volatile, typically 3 to 5 times more so than bonds.
- Consider how much interim loss you can withstand; historically, a well-diversified stock fund could experience an interim loss (also known as a drawdown) of up to 50%.
- 100 minus your age: a simple rule for determining how much to allocate to stocks is to subtract your age from 100. For example, if you are 35 years old, you would allocate 65% to stocks and the remaining 35% to bonds.
- When in doubt, a 60% allocation to stocks and 40% to bonds is a solid choice. See our previous newsletter.
- Some templates/categories of allocations:
- Aggressive Growth: 90% or more in stocks and risk assets
- Growth: 80% or more in stocks and risk assets
- Moderate: Around 60% in stocks and risk assets
- Conservative: Approximately 40% in stocks
- Very Conservative: About 20% in stocks
- Additionally, you can use target date funds if they are available in your plan.
These are just a few quick ways to get you started, after which you can gradually refine your approach and deepen your understanding.
Step 2: Asset allocation strategy
Once you have determined your risk profile and stock-to-bond allocation, it’s time to further diversify your investments. You can easily follow some allocation templates provided on this page: Asset Allocation Portfolio Templates.
For example, the simplest approach is to invest solely in U.S. stocks and bonds. However, you can also allocate a portion to international stocks, REITs, and other assets, similar to the template portfolios shown in this table, which all maintain a 60% allocation to stocks and 40% to bonds.
| Name | YTD Return | 1Yr AR | 3Yr AR | 5Yr AR | 10Yr Ar | 15Yr Ar | 20Yr Ar |
|---|---|---|---|---|---|---|---|
| Four Core Asset Portfolio | 14.56% | 19.72% | 3.38% | 7.22% | 6.76% | 7.75% | 6.94% |
| Five Core Asset Portfolio | 14.68% | 19.76% | 3.25% | 7.14% | 6.69% | 7.68% | 7.04% |
| Three Core Asset Portfolio | 15.39% | 20.19% | 3.89% | 7.78% | 7.11% | 7.91% | 7.05% |
| Two Core Asset Portfolio | 18.05% | 23.12% | 5.04% | 9.10% | 8.36% | 9.38% | 7.81% |
| Yale Endowment Template | 13.62% | 20.16% | 2.72% | 7.51% | 7.32% | 8.85% | 7.86% |
| S&P 500 Index | 27.90% | 34.25% | 10.57% | 15.70% | 13.31% | 14.08% | 10.54% |
You might be surprised by how effective these simple portfolio templates can be, especially when you look at their long-term returns. Of course, you can also explore more advanced strategies if you’re interested.
Step 3: Choices of funds or investment options
Now that you’ve settled on your allocations, you can begin selecting funds for each asset class. Here are some key factors to consider:
- Diversification: When in doubt, choose broadly diversified index-based funds. Index based diversified funds with low cost have outperformed majority of other actively managed funds.
- Ultra-low cost: Select funds with ultra-low costs or expense ratios. Nowadays, any expense ratio above 0.5% is considered “expensive.” For index funds, aim for an expense ratio of 0.3% or lower.
Refer to the AAII (American Association for Individual Investors) article Selecting Asset Classes for Retirement Investments for more discussions on asset classes and fund choices.
Step 4: Regular rebalance
The final step is to have a regular schedule to review your investments (portfolio) and perform necessary rebalance — i.e. buy and sell to bring your portfolio allocation back to your target. In general, you really don’t need to rebalance often, just semi-annually or even annually, unless your portfolio is following some more active strategies.
As always, the most important edge or deciding factor for your investment success is to be consistent and rigorous.
Tools & Tips: How to Determine the Amount to Contribute to Maximize Your Company Match
A company’s 401(k) plan typically includes a paragraph or two outlining its match policy. Unfortunately, some of these policies can be a bit ambiguous. Additionally, there is an important nuance to watch out for:
The match limit specified in the company policy is typically calculated based on each pay period rather than the total annual salary.
In our previous newsletter March 27, 2023: 401k Company Match: How To Maximize Your Free Money, we gave the following example:
A subscriber aimed to invest early by allocating a large portion of each paycheck to his 401(k), intending to quickly reach the annual contribution limit and maximize time in the market. He set a 40% contribution rate, assuming this would also secure the full 4% employer match. However, the company’s 4% match is applied per pay period, not just annually.
For example, with a $20,000 monthly gross pay (or $10,000 bi-weekly), a 40% deduction results in a $4,000 bi-weekly contribution. But the 4% match applies to the $10,000 bi-weekly pay, yielding only $400 in matching contributions per period. This means the subscriber’s contributions max out after 6 pay periods ($22,500 limit reached), earning $400 × 6 = $2,400 in matching.
If he had spread contributions evenly across all 24 pay periods ($22,500 ÷ 24 = $937.50 per period), he would receive a $400 match every period. This approach would result in $400 × 24 = $9,600 in matching—$7,200 more than the previous scenario. The total contribution and match would then be $22,500 + $9,600 = $32,100, remaining within annual limits.
Our Traditional 401(k) vs. Roth 401(k) Calculator is available on our Resources > Calculators page. This calculator helps you determine whether investing in an after-tax Roth 401(k) option is more advantageous than a traditional pre-tax 401(k) option. It evaluates the tax savings and potential growth of those savings when invested under the pre-tax 401(k) option and compares them with the benefits of the Roth 401(k).
We are working on an intelligent match calculator that’s aimed to each specific company’s match policy. For now, you can take a look at the EXXONMOBIL SAVINGS PLAN Contribution & Match.
Thrift Savings Plan (TSP): The Largest Public Sector Workers’ Retirement Savings Plan
The Thrift Savings Plan (TSP) is a retirement savings program for U.S. federal employees. The following are some interesting facts:
Participants and Asset Size
- As of December 31, 2023, the TSP had approximately 7 million participants
- The total assets under management exceeded $845.4 billion as of December 31, 2023
Funds and Expense Ratios
The TSP offers 15 funds for investors, including both traditional and Roth versions
These funds are known for their ultra-low expense ratios:
- Five individual funds:
- One dealing with government securities (G Fund)
- Four tracking specific market indices
- C Fund (tracks the S&P 500, large-cap U.S. stocks): 0.048%, compared to the Vanguard S&P 500 ETF (VOO) with an expense ratio of 0.03%, or the SPDR S&P 500 ETF Trust (SPY), which has an expense ratio of 0.0945%.
- S Fund (tracks the Wilshire 4500 Completion Index, small-cap U.S. stocks): 0.079%, compared to the Vanguard Small-Cap ETF (VB), which has the lowest expense ratio at 0.05%.
- I Fund (international stock index): 0.053%
- F Fund (fixed income index): 0.058%
- Ten target date funds:
- Known as “Lifecycle” or “L” Funds
- Designed to adjust allocation mix among individual funds as employees approach retirement
As the world’s largest defined contribution plan, maybe TSP can further negotiate and reduce its already ultra-low expense ratios for their funds?
Interesting readers can refer to Federal Employee Thrift Savings Plan for some of highly competitive investment model portfolios for TSP plan participants.
Market Overview
The following table shows the major asset price returns, as of last Friday:
| Asset Class | 1 Week | 4 Weeks | 13 Weeks | 26 Weeks | 52 Weeks | Trend Score |
|---|---|---|---|---|---|---|
| US Stocks | 1.1% | 5.4% | 7.1% | 15.0% | 32.9% | 12.3% |
| Foreign Stocks | 1.2% | -0.6% | -2.5% | 1.7% | 12.5% | 2.5% |
| US REITs | 1.8% | 5.3% | 3.9% | 20.2% | 21.9% | 10.6% |
| Emerging Market Stocks | 0.1% | -2.5% | 1.7% | 6.1% | 14.8% | 4.0% |
| Bonds | 1.4% | 1.3% | -0.3% | 4.3% | 5.7% | 2.4% |
The year-end rally continues.
Enjoy the ride, but don’t become complacent
As we enter a seasonally favorable period for stocks, many of us are seeing steady growth in our retirement savings accounts—whether it’s a 401(k), 403(b), or IRA. It’s a great time to celebrate the holiday season with the added cheer of financial gains.
That said, we want to remind our readers to maintain perspective. The current bull market, which began in 2009, is one of the longest in modern history. Additionally, U.S. stock valuations are among the highest ever recorded. History has shown us that financial markets operate in cycles of ups and downs, and a down cycle is inevitable at some point.
While we encourage you to enjoy the present gains, it’s wise to remain vigilant and prepared for market corrections. Just as we celebrate in times of growth, we’ll also be here to provide encouragement and confidence during bleak periods. Let’s navigate this journey together—through the highs and the lows—toward long-term financial well-being.
Struggling to Select Investments for Your 401(k), IRA, or Brokerage Accounts?