How to Invest in a 401k

401k plans often require that you pick your own investments.  If you’re like most people, you might not know where to begin.  Fortunately, you probably have some resources available to you, and you can also figure a few things out on your own if needed.  Let’s review the basics of how to invest in a 401k plan.

Help and Advice

The first thing you should do when you enroll in your plan is ask if there is any advice available to employees like you.  In most cases, there is somebody out there who can help you figure out how to invest in the 401k plan.  It may be a representative at your 401k plan’s investment provider, or a local financial advisor who will sit down and talk with you one on one.  Either way, it’s a good idea to use these resources.  They know that employees are often overwhelmed when it comes to choosing investments, and it’s their job to help you.

On Your Own?

If nobody is available to talk to you, you may need to take matters into your own hands.  However, that doesn’t mean you have to do it completely alone.  You can always ask somebody who is not affiliated with your 401k plan for help.  Local financial planners (with the proper licenses and credentials) can be a great resource.

You can also get a lot of good information by reading through your enrollment materials and doing research online.  You may find that it’s enough to help get you started.  Your enrollment booklet will tell you about investing in your specific 401k plan, but you may want to study up on the basic concepts as well. The Securities and Exchange Commission provides some great resources in the Beginner’s Guide to Mutual Funds, and you can also find helpful investing tips elsewhere.

Which Investments to Choose

To invest in most 401k plans, you’ll choose one of two options: you can build your own portfolio, or you can select some sort of “package” that offers a more hands-off approach.  If investing is new to you, and you don’t intend to put a lot of time and energy into it, it’s probably best to go with one of the hands-off approaches.  Why?  Doing it all yourself takes a lot of hard work.  You can certainly do it if you want to, but you’ll have to spend time researching and reading through materials that you may not find very interesting (and they might be downright boring).  Plus, once you start doing it yourself, you have to stay on top of things.  You have to continually monitor your account, research investments available in your plan (which will change from time to time), keep track of the markets, study the economy, and so on.

For many people, it’s just not worth the effort.  They’re smart enough to do it, but they make a conscious decision not to.  They’ve decided that they would rather spend their time doing other things, whether it’s working or something more enjoyable.  They might even believe that’s the money managers in their 401k do a better job than they could ever do on their own.

If you’re not one of those people (if you’re interested in building your own portfolio), you might want to skip the rest of this article, as it is written mainly for people who want a simpler, hands-off approach.

Your Investment Options

When you look at your menu of investments, you may not know what to pick.  So let’s make sense of what those investment options are, and what they do.  In general terms, there are two types of investment options (in most 401k plans, although it certainly not unheard of for plans that have only one type of investment).  First, you have your individual funds, such as large cap growth funds, international funds, sector funds, etc.  These are most likely not the investment options that you’ll use.  If you want things to be automated, you’ll want to look for the “asset allocation” funds.  These go by a number of different names, including target date funds, lifecycle funds, lifestyle funds, and risk based funds.  They may even go by an entirely different name (depending on brands used or the investment provider of your 401k plan), but hopefully they will be listed separately in an “asset allocation” section.

In general, it’s a bad idea to pick just one investment in your 401k plan.  Why?  You may be better off spreading your money around so that you’re not in the wrong place at the wrong time (and it might even help you to be in the right place at the right time).  If you put all of your money in one of the individual funds, you’ll have everything invested just one type of investment (large cap growth, for example).

With asset allocation funds, it’s a little bit different.  It’s OK to just pick one asset allocation fund – as long as you know what you’re getting into and as long as you pick the right one.  Asset allocation funds are technically “funds of funds.” That means that they hold several other mutual funds inside of them.  As a result, when you pick one asset allocation fund, you actually end up investing in several underlying funds.  Asset allocation funds might own anywhere from 5 to 30 different underlying funds and that means that your money could be spread out among thousands of investments across the globe.  Not bad for just one investment.

How do you know which asset allocation fund to use?  First, you’ll need to figure out who you are as an investor.  This is an essential step-you cannot take a completely hands off approach to your future.  They are a number of ways to figure this out, but a risk tolerance questionnaire is often a good way to start.

If you want to be a conservative investor, you can often find an investment option called something like the “conservative fund” and that might suit your needs.  However, it’s a good idea to look under the hood and get a feel for whether or not that fund is really what you want, and if their definition of conservative the same as your definition of conservative.  The same is true for moderate and aggressive funds.

Or, your 401k plan might use target date funds.  In that case, use the fund if that’s at a level of risk that makes sense to you.  Keep in mind that might not be the fund that lines up precisely with your retirement date.

Once you’ve picked an investment, make a note somewhere of why you chose that investment.  What are your goals for that investment?  What do you expect from it?  From time to time (perhaps every 6 to 12 months) you’ll want to revisit these goals and expectations to see if you’re using the right investment.  Of course, there’s no way to predict anything, and we may lose money when you we’re hoping to earn money.  The important thing is to see how your investment does relative to the level of risk that you thought you were taking on.  If you lose a lot more money than you ever expected (taking into consideration the market as a whole) then you may need to reevaluate the amount of risk you’ve taken on and the investments you’re using.  Maybe you need to water things down a little, or maybe not.