Everything You Wanted to Know About Investing in Your 401(k), But Were Too Afraid to Ask



Investing for retirement can seem daunting. With so many retirement plan options, and even more jargon that comes with the territory, it’s no wonder people can start to feel anxious when figuring out how to invest in their 401(k) properly. Luckily, the first step is easy—all you have to do is start saving your money and putting it in a retirement account.

As for the rest? Investing in your 401(k) doesn’t have to be complicated. From understanding your investment options, to choosing your portfolio, to common mistakes to avoid, I’ve broken down how to invest for retirement so that you can start understanding how it works and do it on your own. Here’s everything you wanted to know about your 401(k). Learn the basics here, and start to feel confident in knowing you’re building a retirement nest egg.

What is a 401(k)?

Let’s start by answering what’s probably your first question: What is a 401(k)? Simply put, a 401(k) is a retirement account sponsored by your employer. If you work for a non-profit, a school district, or the government instead of a company, your retirement plan might be a 403(b) or a 457(b) plan. These weird names come from the IRS code sections that created them. But don’t worry—your employer picks the plan, and most of the information here applies to all of these.

You and your employer can both contribute to a 401(k). Many employers match your contribution to some degree, and some contribute a portion of company profits to employees’ accounts. In 2017, the maximum amount you can contribute to a 401(k) is $18,000, with an additional $6,000 allowed for those over the age of 50. The total amount that can be contributed to a 401(k), including matching funds and other contributions from your employer, is $54,000.

Step 1: Get started and match your funds

Contributing is easy—just tell your payroll department how much to withhold from each paycheck. Traditional 401(k) contributions are not included in your taxable income when you put the money in, and you get taxed once you take that money out in retirement. Some companies also offer a Roth 401(k) option, which means the opposite—the money is taxed going in, but you don’t get taxed when you take it out (with some conditions). More about this later.

How much should you contribute? The short answer is as much as you can afford. The more you save for retirement and the earlier your start saving, the better off you’ll be in retirement. If you’re lucky enough to have an employer that matches your contributions, at a minimum you’ll want to take full advantage of your employer match, because you absolutely want to get that money. How much of your 401(k) contributions your employer will match varies, and companies can be imaginative with their match formulas, so find out what your employer’s system is and contribute at least enough to get the full match.

Step 2: Roth or Traditional?

If your employer does not offer a Roth option, you have no choice. If it does, there are benefits to both options. When considering between the two, the question is: Do you want to be taxed now or taxed later?

Remember, with traditional 401(k)s, the money is taxed when you take it out. With a Roth, you are taxed before your money is put into the account. So what you’ll really want to consider is whether you’ll be in a higher tax bracket when you retire than you are now.

If you’re early in your career trajectory and your salary will probably increase later, you might want to consider a Roth, because the money will be taxed at the bracket you are now, not at the (presumably) much higher one you’ll be in when you retire. If you’re in a high tax bracket now and have few deductions, a traditional (deductible) contribution is an easy way to turn money you’d pay in taxes into retirement savings.

The reality is that most people don’t know their tax bracket today, let alone what their tax rate will be when they retire 20 or 30 years from now. But rest assured that the more you save now, the better off you’ll be in retirement. If a tax break today motivates you to save more, then go with a traditional 401(k).

Step 3: Invest your contributions

The investment choices available to you depend entirely on what your company’s plan offers. Most 401(k) plans offer a selection of mutual funds, but some offer only a few choices, and others offer hundreds. Some also have the option of a stock brokerage account in which you can buy stocks, bonds, and ETFs, and there are even a few employers out there that allow you to buy their own stock in your 401(k).

Before we talk about investments, we need to talk about you. According to CNN, 93% of millennials say that they distrust markets and lack investing knowledge, and that it makes them less confident about investing. How much time and effort do you want to put into managing your money? If you’re willing to take time to research investment options, monitor how your portfolio is performing, and make adjustments as economic and market conditions change, you can do that. If not, consider having your money managed—either by a money manager, or by investing in a target date fund.

A money manager will charge you something for their service, usually a percentage of the amount they are managing. They will decide the right mix of funds based on your age and risk preferences. The exact cost and methodology varies from firm to firm, but for some people it is worth the cost.

A target date fund is a mutual fund with a passive mix of investments aimed at a “target” retirement date. They have low fees (Vanguard’s charge is about 0.16%) and their mix of assets (stocks and bonds) becomes more conservative as your target retirement date nears. For many people, especially those who want to set up their retirement accounts and then stay hands-off, these funds can be a good investment option.

Something to keep in mind is that you don’t necessarily have to pick the target date based on when you actually plan to retire. If you feel the mix of assets is too aggressive, then select an earlier retirement year to take less risk. It’s important that you not feel nervous. If you’re nervous, you risk making classic mistakes, like selling everything in a panic when the market goes down instead of waiting out the down periods.

If you’re willing to do the investing homework and don’t want to just stick your retirement savings in a fund and forget about it, then self-investing is an option. Not all have this option, but some 401(k) plans let you buy individual stocks rather than mutual funds. If you’d rather invest independently, then it’s probably safe to assume you like researching stocks and enjoy making your own decisions.

If you’re not sure how to get started with making your investments, consider looking at a target date fund that matches your target retirement date. Then you can use their asset allocation strategy as a jumping off point for your own investments. After that, you can make up your own mix of assets from the plan’s available choices.

Step 4: What’s your risk tolerance?

Whether you’re picking a target date fund or making your own mix of investments, you’ll want to allocate your money based on your needs and risk tolerance. By that, I mean the mix of stock and bond funds that you choose will depend on your age—how long you have until you retire and need to access this money—and how much risk you’re comfortable with.

A SoFi advisor can talk to you about how much risk you should be taking. As a rule of thumb, if you’re young, then now’s the time to take some risk. You have time to recover from market drops and more time for riskier investments to pay off. If you’re closer to retirement, then you’ll want to adjust your timeline such that your money will grow in the early stages of your retirement, ensuring you don’t outlive your money, but you are not risking so much you can’t survive a market downturn.

Step 5: Coordinate your 401(k) with your entire investment portfolio

This is kind of an advanced strategy. Once you’re an experienced saver and have been investing for a while, be sure to look across all your investment accounts—AKA, don’t just think of your 401(k) in isolation. When you look at the full picture, you can balance your asset allocation across your whole portfolio. You’ll want to consider both the tax shelter a 401(k) provides and the investment choices available to you.

Some securities get favorable tax treatment—like the dividends on stocks. Others don’t—like the interest on corporate bonds or the dividends of real estate investment trusts (REITs). Look at the overall target allocation of your portfolio. Some portion of your overall portfolio is probably allocated to investments whose returns don’t get a tax break. Put them in your 401(k) or other tax advantaged retirement accounts, and put the ones that get a tax break in the taxable accounts. Again, a SoFi advisor can help with this.

Since you’re limited in your 401(k) to what your employer has made available, you may also want to utilize the best fund choices in the plan that fit your asset allocation, and then flesh out the rest of your portfolio in non-401(k) accounts where you have more flexibility.

For example, even if your employer provides very limited choices, your plan probably has an S&P 500 index fund. Your overall asset allocation probably calls for some portion in US Stocks. If that’s the best fund available, consider using it as part of your US Stocks allocation.

Two common investing mistakes to avoid

People tend to make two common mistakes with their 401(k). The first is putting all of their retirement funds into company stock. Putting all your money in company stock, while also working at the company, is a risky move. Even if you love your company and really believe in it, it might be a mistake to put more than five or 10% of your total assets in any company’s stock. Worst case scenario, the company could go out of business—you’re out of a job and you’ve lost your retirement savings. It’s too many eggs in one basket.

The second is putting everything into a money market fund. A money market fund is a mutual fund made up of relatively low-risk, short-term securities. It’s a tempting move, because it feels like you don’t risk losing money. But, since inflation in the US is currently about 2%, and according to BankRate, the national average yield for money market funds is less about 0.11%, you are receiving a negative real return. Your money is losing value after inflation. Your retirement savings need to grow, while there are no guarantees in stock or bond funds, with these return rates, money funds are likely not the answer.

One last thing—don’t forget to rollover your funds when you leave your employer

When you leave your current employer, it’s often a good idea to roll your 401(k) into a traditional or Roth IRA. Most 401(k) accounts have a lot of fees associated with them. An employer will pay those while you work for them, but once you’re no longer with the company, many will stop paying them for you. It makes more sense to move your money so that you’re not picking up the bill for those fees yourself. You’ll also generally have a broader range of investment choices.

Have more questions about your 401(k)? SoFi advisors are ready to help with any questions you have about 401(k)s—go here to see how they can help you. SoFi Wealth also offers both Traditional and Roth IRAs. Learn more about SoFi Wealth. Sign up for a SoFi Wealth Account today.

SoFi Wealth, LLC does not render tax or legal advice. Individual circumstances are unique and we recommend that you consult with a qualified tax advisor for your specific needs.


ABOUT John Foley John Foley is President of SoFi Wealth, an investment management service guided by experts and powered by technology. John has more than 30 years of experience creating and marketing financial services—he has held various investment advisory and product roles at Charles Schwab, eTrade, and Intuit. He has FINRA Series 7, 24, 63, and 65 certifications and is a Certified Financial PlannerTM. John holds an MBA from San Francisco State University and a BA from the University of Scranton.


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