How to invest your 401(k)

Can you invest your 401(k)?

Yes! In fact, your 401(k) is already invested on your behalf. Every time you contribute some of your paycheck into your 401(k), it is automatically invested for you. If you don’t make specific selections of where you want your money invested, it is put into default options set either by your employer or the plan fiduciary. This is usually a mix of target-date or asset allocation mutual funds (see below), but will vary.

The second part of this question is more important. Can you select the investments in your 401(k)? That answer is also yes! You are the investor and have control over your 401(k) management. You can often choose from a menu of around 30 options between various exchange-traded funds (ETFs) and mutual funds like U.S. stock, international stock, bond and index funds. The options you have will depend on the company that operates your 401(k). Even if you decide not to change a thing, it’s important to understand your options and how they will affect your account’s growth. A good example of this is that some funds have higher fees associated with them, which means even if they have a better return year over year, they may still underperform compared to an option with lower fees, like an index fund.

Since everyone’s current situation and future goals are different, the information in this article, or any article for that matter, should not be taken as individual investment advice. Instead, use this information as a guide as you discuss your retirement goals and needs with an experienced financial professional.

What exactly is a 401(k)?

A 401(k) is simply a type of retirement savings account that holds investments on your behalf. You can think of it as a wallet that holds your money in different pockets. A 401(k) is usually provided by your employer and has several different tax benefits that make it a more attractive option for long-term retirement savings than other types of accounts. In addition, many employers offer to match your pre-tax contributions up to a certain percentage of your salary, which is basically free money. Learn more about the basics of a 401(k).

Why change the investments in your 401(k)?

If you don’t choose where your 401(k) is invested, someone else is choosing for you. That someone doesn’t know who you are, where you come from, or what your goals are. They are usually making selections based solely on your age and how much you contribute. Nothing about that is personal. Even if you think you would rather be hands-off and should trust a professional, you should likely be consulting with an independent financial advisor that can help educate you on asset allocation, risk tolerance, and dollar-cost averaging.

401(k) steps: How to choose 401(k) investments

This section covers the steps you need to take to change your 401(k) selections. If you’ve never logged in to your account, you may need to set that up as well:

Log in to the company that handles your 401(k)

The first step to choosing your 401(k) investments is finding out where your account is held. If you don’t know who operates your 401(k), there are a few ways to find out. First, check your mail. You likely receive quarterly or yearly envelopes that detail your account’s growth. Or you can ask your employer’s plan manager or HR department.

Once you know who your plan manager is, you’ll need to log in to your account on their website (you may also need to create an online account). This should give you access to a number of features where you can monitor your growth, calculate your retirement savings needs, and change your investment selections.

How do you change what your 401(k) is invested in?

Now that you’re logged in, exactly how do you invest your 401(k)? Well, it will vary from provider to provider. Usually you can do it online, but in some cases, you may have to call.

First, find out what your investments are currently in. Look for your plan summary or “investment performance.” What you’ll find is likely a confusing stream of numbers and letters, such as TRP LRG CAP GR TR D. Unless you already understand the lingo, that isn’t going to tell you much. Usually clicking on it will give you more information, including a summary of the stocks within it, historic performance, and fees.

Then, if you want to make changes, you’ll look for something like “change investments.” From there you should be able to either change your current investments or select where new contributions will go. Usually there is a menu of different options, and some of them may be recommended for you.

How often can you change your 401(k) investments?

This will depend on your plan and the specific funds you’ve invested in. Many have restrictions on how often you can change your selections, but they will vary greatly from option to option. You should also check if there are any fees when changing investments from one fund to another, as that can eat into your portfolio’s growth in significant ways. At the end of the day, it’s usually best to choose where you want to invest your 401(k) and revisit yearly.

401(k) investment options

Now that you know the steps for changing your selections, how do you pick 401(k) investments? That will depend on your current situation and your future goals. Below are the basics of several common types of funds you can choose from, as well as some pros and cons.

It’s particularly important to pay attention to fees. Mutual funds and ETFs are managed by people who choose when to buy and sell certain investments within the fund. For their efforts, they charge a fee to cover operating costs, usually represented as an Expense Ratio—which is an annual fee expressed as a percentage of your investment in that fund. For example, an expense ratio of 1% would mean you pay $10 a year for every $1,000 you have invested in that fund. For example, an expense ratio of 1% would mean you pay $10 a year for every $1,000 you have invested.

The difference between a fund that has a 1% or more expense ratio and an index fund that may be as low as .0065% may not seem like much, but it can be significant. Because growth is tax deferred (which means contributions and earnings are not taxed until withdrawn) and compounding interest is so powerful, even a little bit saved in fees when you are young can have a large impact on your overall account by the time you retire.

As with most investments, the following options have the possibility of significant growth but are also subject to market risks. Your investments will fluctuate over time and there is always the potential of losing value if the markets decline.

Target-date funds

These funds usually have a year in the name, like 2050. They are focused on having a balanced set of assets between stocks and bonds for someone retiring in that year. If it’s still far away, that balance will usually contain more stocks and fewer bonds, which is considered higher risk with higher potential growth. Then as the date approaches and arrives, the mix will become more conservative, usually by selling stocks and holding more bonds. If you want to choose target-date funds, simply pick the year that’s closest to when you think you’ll retire.

Asset allocation funds

Instead of your planned retirement year, asset allocation funds are usually “all-in-one” investment options that mix stocks, bonds, and other assets based on your risk tolerance. For example, someone who is younger might prefer a risk-based fund that allocates 70% to stock investments, 20% to bonds, and 10% to “cash” investments, such as money market funds.

Specialty funds

Or you might look at funds primarily invested in the tech sector, or perhaps one focused on commodities like gold. These would be specialty funds, and based on their nature, they require slightly more knowledge or understanding of your goals if you want to choose these for your 401(k) investments, as they can be more volatile than other investment types because of their narrower scope.

Index funds

Index funds contain a wide mix of stocks in an attempt to track the performance of a specific market index, like the S&P 500 or the Dow Industrial. They are often less volatile than other choices because they are about as diversified as you can get, but they are still subject to risk. If the overall market has a downturn, so will your investment. The main selling point of index funds is that they are “passively managed,” which means there isn’t someone actively buying and selling the investments within the fund. Lower fees are usually associated with index funds.

Large-cap vs. small-cap funds

Market caps are another indicator common among 401(k) investment options. They can be added as a descriptor to many types of funds, including target-date and asset allocation funds. “Large-cap” basically means big companies with capital of $10 billion or more. Many see these larger companies as more stable and predictable. “Small-cap” on the other hand refers to smaller companies. Smaller companies may be riskier but frequently offer a larger potential for growth.

401(k) investment strategy by age

We certainly can’t give you specific or customized investment strategies in an article. That should fall to you and your financial professional. Your 401(k) management will depend on many factors, like your current profession and salary, where you live, what your retirement goals are, how large your family is, and more. The list goes on. That said, here are some rough guidelines to consider, by age:

401(k) investing in your 20s and 30s

There’s an old saying that “time in the market is more important than timing the market.” Basically, it means that the longer you have investments outweighs what you invest in. The most important thing you can be doing right now is simply contributing to a 401(k). At the very least, know if your employer provides matching contributions and allocate that much to your 401(k). As for where or how you should invest—when you are young, most financial professionals would say you have time to be more aggressive in your 401(k) investment strategy. That might mean asset allocation funds with a higher proportion of stocks to bonds or investing heavily in index funds.

401(k) investing in your 40s

Your 40s are generally considered your prime earning years, and this is when you should really think about putting in enough to max out your 401(k). That means allocating enough to reach the annual 401(k) contribution limits. Because of the tax advantages and possible employer matching, it’s often advised to do this before investing money in other ways. The contribution limit normally goes up a little every few years, so check back in on your contributions regularly. You may also have changed jobs several times by this point, and possibly have 401(k)s from old jobs lying dormant. If that’s the case, you might consider a 401(k) rollover. Your investment choices at this stage will likely depend on how much progress you’ve made. If your 401(k) is on track and happily growing, it might be time to scale back a bit on your risk profile. However, if you are behind on your goals, you may consider looking for the higher growth potential that often comes with riskier choices.

401(k) investing in your 50s

As you get closer to retirement, your 401(k) should be quite sizable due to years of compounding interest. If you don’t already, you should have a clear picture of how much you’ll need for retirement and whether you are on track or not. Some may still need to catch up on retirement savings, and that’s okay. For others, you may now want to rebalance toward protecting that nest egg instead of growing it further. Bond mutual funds invest in a basket of individual bonds including government, corporate, and municipal bonds. They usually return less than stock mutual funds over the long term, but play a crucial role in reducing risk and providing steady income.

The rule of 110

This is an investment guideline that helps you determine how much of your 401(k) should be in stocks vs. bonds. Using this rule is easy. Simply subtract your age from 110, and that is how much this rule says you should have invested in stocks—with the rest in bonds or equivalent. An example for someone who is 40 years of age is: 110 – 40 = 70% in stocks and 30% in bonds. The rule is simple, but that also means it might not be the best solution for you. In fact, this rule has changed over the years. It used to be the “rule of 100.” Now many financial professionals are suggesting a more aggressive approach, the “rule of 120,” since most of us are living longer. If you want more nuanced and customized guidance that takes your situation and goals into account, we can connect you with an experienced financial professional who can help you determine what is best.

401(k) investing FAQs

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