How do I maximize my 401K investments in a Covid-19 world?
In this turbulent time period, I'd like to make sure I'm maximizing my returns in my 401K, or at least minimalizing my losses as the case may be. I'm 44 and plan to work for at least 10 more years. What types of mutual funds should I be focused on now and which types should I avoid.
Large-cap, small-cap, international, index funds. They are all out there. In addition, my 401K provider offers a brokerage link account that I utilize to by individual stocks. Is this a good idea or a bad idea?
Thanks!
Peter
Answers ( 1 )
First: congratulations to you for thinking about your financial future. Americans are continuously hammered with advertisements trying to convince them that the only way happiness is to spend every penny they earn on whatever shiny doodads they can. You want to grow your investments into wealth that you can use later in life, which will reduce the stress you feel from financial pressure. That's terrific.
However, "maximizing my returns" is an elusive goal. If someone knew how to do this, they wouldn't tell you -- they'd just go earn 30% or 40% or 50% on their investments per year and just turn themselves into Warren Buffett. So you're never going to find a specific answer to that question here.
And there's really nothing special about today's turbulent times -- we wouldn't know what stocks to pick if times were good, either! There might be billionaires with specific, insider knowledge about various companies that allow them to make better choices in the market than we can -- but no amount of study we could do would ever close that gap. There's just too much to know that isn't public knowledge.
But there's a general method that does work. Whether you’re saving for retirement or seeking wealth through the magic of compound growth, the idea is really just a simple three-step plan:
The first thing you want to realize is that you do not need to find a way to spend every last cent you earn. :-) No matter what you earn or where you live, there is someone living near you who earns less and still leads a happy life. Live like that person. The rest of this answer will give you ideas about how to take advantage of the difference between what you make and what you spend so that you can invest for retirement, where you can reach the point where you can do whatever work you do because you *want* to, not because you have to. That kind of freedom is a very nice feeling!
In America, you'll want to use legal ways to avoid taxes where you can. Your employer probably has a web site describing your options: a 401(k) plan -- especially if it includes a match from your employer, where they contribute if you do -- is usually at the top of the list. Other things include a 403(b) (if you're at a non-profit), 457 (if you work for some states), and 529 (if you want to save for your children's future expenses). You can also fund your own Traditional IRA if you want, directly through a brokerage like Vanguard or Fidelity. You can't do *all* of them, though; the IRS determines which combinations you can do.
All of these are tax-deferred, meaning that the money you invest won't be taxed now (and that lowers your tax at your marginal rate, which is probably at least 22% plus whatever your state income tax is). It puts the money away until you're 59.5 or thereabouts and then you finally pay income tax when you take it out (but if you've stopped working by then, it'll almost certainly be at a lower rate because it'll be your total tax rate, not just the higher marginal rate).
There are limits to how much money you can put into these, though, and if you're disciplined about investing, you're probably going to hit them. :-) That's okay, you have more options: the Roth IRA is like a 401(k), but you pay taxes now, but never have to pay taxes on any of the profits, ever. You'd set one up through Vanguard or Fidelity, there's a $6,000-per-year limit on that. It has one other nice feature -- you can take your contributions out in an emergency if you have to, without any penalty, as long as you leave the profits you've made in there (and then you can put the money back in if you want).
If you exceed all of those limits for contributions, you can keep going in other ways -- it won't have the tax savings that the other money does, but it's still going to grow in a compound, exponential way. Vanguard or Fidelity are good spots to do that.
Which funds should you pick? My advice is super-low-cost, passively-managed, widely-diversified index funds.
Super-low-cost means that the OER (Operating Expense Ratio) charged by the brokerage is no more than 20 cents, per $100 invested, per year -- or 0.20%. You can now buy funds that have driven that OER all the way down to zero!
Passively-managed means that there isn't a human or team of humans who run the fund trying to "beat the market". The problem with that is they (a) need to be paid, by you and the other investors, and (b) they beat the market, on average, only about 40% of the time. A chimp could do better and gets paid in bananas.
Widely-diversified means the fund includes lots and lots of stocks and/or bonds so that you're not exposed to one particular company. You don't want to be that guy who puts his entire retirement fund in Enron stock, then loses the whole thing. There's no need for you to gamble; you're going to pile up a lot of money playing it safe.
Index funds try to match well-known stock indexes like the S&P 500 or the MSCI International index. The managers of these funds don't try to pick the best stocks; they just try to match these publicly-known indexes as closely as they can. For the most part, they're just buying shares in the appropriate amounts; that's why they can charge so little to their investors.
If you don't want to pick and choose index funds yourself, there's good news -- you can just take your birth-year and add 60 then go to Vanguard and invest in the Vanguard Target Retirement Fund that's closest to the year you calculated (you'll want your fund to be with Vanguard in that event). That fund invests in stock index funds and bond index funds, both US and International, in such a way that will be aggressive when you're young and more conservative as you age, which is exactly what you want to do with a long-term investment -- and it'll happen automatically, without you having to keep track of it.
Some of these investment types, like the 401(k), might be required to be with your employer's broker of choice and you might have a limited number of options for investment funds. That's okay, there's almost always a few funds that are pretty low-cost, passively-managed, diversified index funds. If you want, you can look at the ratios of stock vs. bond, US vs International funds in the Vanguard Target Retirement fund you want and replicate those ratios as closely as you can in your own investments outside of Vanguard. It'll take a little work on your part to keep up with the changing Target fund, but you can actually save a little bit of the OER expense (and you're going to soon have a LOT of money, so it'll be worth it to do so).
Finally, do it automatically. Figure out where you want your money to go and how you want it invested, then have the money taken out of your paycheck before you ever see it. When you get raises and promotions that bump your salary, bump up your investments, too. This is a strategy that will put you on the path to being a multi-millionaire without much chance of failure, to be honest -- if you're 25 years old now, you'd likely be ticking off your third million before you're 50. There are no guarantees in the world, of course, but based on the history of the world economy, you'd be as likely to do *better* as to do worse.
Good luck to you!