 In
this article we focus on helping you make choices in your employer's retirement
plan.
Most employers
offer some type of retirement plan to employees, including 401(k) plans, 403(b)
plans, section 457 plans, SEP-IRAs, and SIMPLE IRAs. In most cases, the employee
is given the option of making contributions to the plan and is then able to choose
how to invest the money from a given list of investment choices. For the new investor,
this can sometimes be a difficult task. Many questions arise: Should I pick the
fund with the best return; Should I diversify among many different funds; How
should I choose which funds best suit me? Step
1: When Will You Need this Money?
The
Henssler Financial Group believes the best way to determine your asset allocation
inside your retirement plan is ask yourself when you likely will need the money
you are saving in your retirement plan. We believe that funds needed within 10
years should be invested in fixed income securities, and funds not needed in ten
years should be invested in equities. Therefore, unless you are entering the workforce
at a later age, you likely won't need the funds in your retirement plan for at
least 10 years. Withdrawals from a retirement plan before age 59 ½ currently
are subjected to a penalty tax of 10%, in addition to the regular income taxes
that must be paid on the early withdrawals. Mandatory withdrawals from retirement
funds are not required until the account holder reaches age 70 ½, at which
point the law dictates that you must begin withdrawing funds from your retirement
accounts. So, your first step should be to estimate whether you would need any
of the funds in your retirement plan in the next 10 years.
Step
2: Invest Funds Needed within 10 Years in Fixed-Income
If
you determine you may need some of the funds you are saving to your retirement
account within the next 10 years, we suggest you consider investing the portion
you may need in either a money market fund or a short-term bond fund. Long-term
bond funds or funds that invest in bonds that mature in 10 years or more, should
be avoided, as the risk to principle is too great. The whole reason you are investing
money in bond funds, or money market funds, is to protect the principle that you
will need to eventually withdraw within 10 years. Funds that invest in fixed-income
securities will often have the word "income" in the title, although
some income funds also invest in stocks that pay healthy dividends. If you are
a Henssler Advice subscriber, you may check your list of funds against our recommended
mutual fund list. You shouldn't switch your contributions into bond or money market
funds because the stock market gets "scary." Scary stock markets often
provide the best times to buy stocks at relatively inexpensive prices. You should
also avoid balanced funds, as we prefer that you keep your equity portion of your
savings in equity funds, and your fixed-income portion in fixed-income. Balanced
funds often muddle this mix, making it more difficult to tell how much exposure
you truly have to the equity markets.
Step
3: Invest All Other Funds into Equity Funds
All
funds that you don't believe you will need within 10 years should be invested
into equity funds. Your contributions should be allocated 100% each paycheck into
equity choices within your plan. If you have held a portion of your plan savings
out of equity funds, but are now ready to begin moving these funds over, you should
take a dollar-cost-averaging approach. Plan how many months you would like to
take to move your money market or bond fund balance into equity funds. We suggest
12-15 months. Each month, move approximately the same amount from the fixed-income
fund to an equity fund.
When
determining which equity funds to invest in, we suggest you look at a few things.
First, if an S&P 500 index fund is offered, we suggest you make this your
core holding, and invest at least 50% of your funds earmarked for equity funds
into this option. Other equity funds also should be considered. Again, Henssler
Advice provides a list of our firm's recommended mutual funds. Morningstar is
also an excellent source of mutual fund information. It can be found online or
at most public libraries. You should consider a mix of funds that match your risk
tolerance. Small-cap and mid-cap funds are usually more volatile than large-cap
funds, but often offer slightly higher long-term returns. You also may want to
consider your mix of growth funds and value funds. (See the article explaining
growth vs. value in Henssler University.) Growth funds are generally more aggressive
than value funds. One
mistake often made is to over-diversify by buying many, many different funds.
Often, you might own three different large-cap funds that all invest in basically
the same group of stocks! You never should need more than five or six funds in
your retirement plan, at the very most. Step
4: Review Your Account Regularly You
should review your retirement plan account regularly. However, you should avoid
"chasing returns" by moving money out of one fund into another simply
because a different fund had higher returns. Many funds that were heavily weighted
in technology did extremely well during 1998 and 1999. Those same funds under
performed during 2000, when many of the technology stocks performed extremely
poorly. The people who were truly hurt by this were those investors who waited
until the end of 1999, then moved large sums into these funds because the returns
were high. It's important to compare your funds to other similar funds, and make
changes if your fund is not performing as well as it should. One great measure
of this is the "Category Ranking" feature Morningstar assigns to mutual
funds - this measure compares a fund to funds with similar investment styles. Next,
we'll complete our series on new investors by providing suggestions for other
savings, including IRA contributions, and savings in regular brokerage accounts.
All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. |
