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TL;DR: Choosing 401(k) investments is challenging for non-experts. Relying solely on past performance is risky, and understanding risk tolerance is crucial. Consider target date funds for simplicity, diversify wisely, and seek professional advice—preferably from fiduciaries who prioritize your interests. Don’t invest blindly; know what you’re investing in.
Main Points:
- Choosing 401(k) investments is complex unless you're an investing expert.
- Past performance isn't a guarantee of future success—avoid relying solely on it.
- Understand your risk tolerance to avoid panic-driven decisions.
- Conduct a risk tolerance assessment before making big decisions.
- Know what you're investing in—research the companies behind your assets.
- Target date funds simplify investing but vary in risk levels—choose wisely.
- Diversification helps manage risk—don’t put all your eggs in one basket.
- Seek professional guidance, ideally from fiduciary advisors.
Many of us have 401(k)s through our employers. When you’re first eligible to begin contributing to your 401(k), you must pick funds. For most, this is a bewildering decision. Employees often see a list of unfamiliar funds with confusing terms.
Still, they’re expected to somehow choose 401k investment options that are the best.
If they’re lucky, their benefits program includes a financial advisor. But often, they’re left to figure it out alone. If that describes you, read on for some helpful tips to on how to choose 401k investments that best fit your unique situation.
Research
Investors who understand personal finance and investments will often read Morningstar. They check past 401(k) performance and look for well-rated funds. That’s not a bad start, but there are some pitfalls to watch out for.
At the bottom of this blog post is a disclaimer that says, “past performance is no guarantee of future result.” That’s not just legal filler; it’s there for a reason. Relying solely an asset’s past performance and expecting it to continue can be risky.
A great example is 10-year Treasury bonds. For 35 years, interest rates generally fell, which made older Treasury bonds more valuable. If you buy a bond at a 15% rate of return, then those rates drop, you can often get paid a premium for your higher-interest bonds. That’s why, for decades, you’ve heard that Treasury bonds are safe, stable and a good refuge when the stock market falls.
However, recently we saw long-term bond values drop alongside the market! Earlier this year, an entire bank collapsed because it had too much invested in bonds that were suddenly hard to sell at a profit. People still saying that bonds are completely safe base their assertion on irrelevant historical truths.
Traditionally “safe” investments are not as safe as you might think right now. You wouldn’t know it simply by looking at past performance.
Understand Your Risk Tolerance
My clients would tell you I’m fond of saying that, for a little over a decade, even a blind chicken could make money in the stock market. We had unprecedented growth across the board. Even people who knew absolutely nothing about investing had a decent chance of making money in the market.
When the market experiences an upward trend for so long, people think they’re a lot more risk-tolerant than they really are. They start investing more heavily assuming investing is easy and they will grow their wealth faster if they invest more. However, they forget that risk means… risk!
When the market turns volatile, like during and after the pandemic, they suddenly discover that risk feels very uncomfortable. They want to eliminate the risk, which often means selling their positions. The trouble is panic-inspired selling often leads to selling assets for than they originally bought them.
We call that “locking in your losses.” Once you sell an asset at a loss, you can’t recover what you lost should the market begin to climb again. Inexperienced investors often lock in losses by making emotional, panic-driven decisions. That panic happens because they weren’t as risk-tolerant as they thought!
In short, think very carefully about how much risk you can tolerate. Doing so could save you from harming your financial position through unwise investment decisions should volatility strike.
Conduct Your Own Risk Tolerance Assessment
Before making any big investment decisions, it’s wise to do a proper risk tolerance assessment. This helps you avoid reacting emotionally during market dips and guides your 401k asset allocation. Knowing how much risk you can handle helps you stick to your plan through both highs and lows. This questionnaire can help you determine your investor profile.
In short, think very carefully about how much risk you can tolerate. Doing so could save you from harming your financial position through unwise investment decisions should volatility strike.
Consider what you’re investing in
Investing is about more than just looking at performance charts and picking investments that have gone up the most. The truly savvy investor understands what’s behind those numbers. Do you believe in the organization or asset you’re investing in? In the early 1980s, those who believed personal computers would boom, and bought Microsoft stock because of it, did very well.
On the other hand, many chased the meteoric gains of cryptocurrencies without understanding them. They were quite despondent when crypto recently collapsed! Understanding of the real-world factors behind your investments is crucial. That insight only comes from researching the companies behind the assets.
Best Target Date Funds for Simplicity
If you don’t want to build a portfolio from scratch, consider the best target date funds available in your plan. These funds automatically adjust your 401(k) asset allocation based on your expected retirement year. They offer a hands-off way to stay diversified and aligned with your timeline.
Still, not all target date funds are equal. Some are more aggressive; others lean conservative. Take a closer look at what’s inside before choosing one.
Why Diversification Strategy Matters
A solid diversification strategy spreads your money across different asset types (like stocks, bonds, and cash) so no single dip derails your whole retirement plan. Most 401(k) investment options include mutual funds and index funds. Mix them wisely.
Diversification helps reduce risk and smooth out returns over time. Think of it as your protection against the unknown. Of course, don’t treat your investments as a bag of mixed nuts. Take time to work with certified professionals to find the best options for you.
Get Professional Help
The bottom line is that picking investments as an individual is difficult unless you specialize in investing. If you don’t, it’s a very good idea to seek investment advice from someone who does. However, it’s also important to understand who you’re getting that advice from!
At Asset Preservation Wealth & Tax, our advisors are fiduciaries, meaning we are obligated by the licenses we hold to work solely in the best interest of our clients. Financial professionals with non-fiduciary designations are not constrained by that requirement. If you can, it’s important to seek advice from a professional who will put your interests above their own.
Stewart Willis is the founder and president of Asset Preservation Wealth & Tax, a financial planning firm in Phoenix, Arizona. Investment advisory services offered through Foundations Investment Advisors, LLC, an SEC registered investment adviser.
The commentary on this blog reflects the personal opinions, viewpoints and analyses of the author, Stewart Willis, providing such comments, and should not be regarded as a description of advisory services provided by Foundations Investment Advisors, LLC (“Foundations”), an SEC registered investment adviser or performance returns of any Foundations client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment, legal or tax advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Personal investment advice can only be rendered after the engagement of Foundations for services, execution of required documentation, including receipt of required disclosures. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Foundations manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Any statistical data or information obtained from or prepared by third party sources that Foundations deems reliable but in no way does Foundations guarantee the accuracy or completeness. Investments in securities involve the risk of loss. Any past performance is no guarantee of future results. Advisory services are only offered to clients or prospective clients where Foundations and its advisors are properly licensed or exempted. For more information, please go to https://adviserinfo.sec.gov and search by our firm name or by our CRD # 175083.
