401(k) Investment Advice

In My Humble Opinion
1

About 15 years ago, I set up a 401(k) account back when I working at a private company. I made pre-tax contributions to it for about 4 years, and then went to work for a public agency that does not have a 401(k) plan available. (It has a 457(b) plan instead, which I have also been contributing to.)

Anyway, I kept tabs on the 401(k). It has been orphaned since I left the company, so I can no longer make additional contributions (but I can move money around within it). When I first set it up, I put 50% of the contributions into an index fund, 25% into a large cap growth fund, and 25% into bonds for some reason. I remember reading something at the time in Consumer Reports that the best hands-off long-term investment strategy was to put your money into an index fund for the long haul, and to not worry about moving it to something less risky until you get close to retirement. I took that advice for half my money at least.

So 15 years later, the account has grown, but not equally so. I have records on hand going back to 2010, and the portion invested in the index fund and growth fund both increased by about 3 times (increase of 200%) since then. The portion invested in bonds, on the other hand, has increased by just 30% over that time. The bonds, which started off as 25% of my contributions, now make up just 12% of my portfolio.

So my first thought is that the bonds are obviously under-performing, that I never should have invested in bonds in the first place, and because I am 50 years old and hopefully have 17-20 years more to work, I should move all the money invested in bonds into the index fund.

On the other hand, the advice given on the Fidelity website is that bonds should now make up about 15% of my portfolio, and that I should “rebalance” my portfolio and move some money the other way and into bonds, which is the exact opposite advice.

Any thoughts? Thanks!

Bonus question: my son just graduated from college and started a job with a 401(k) plan available. I need to help him set it up. What should he invest in? I’m thinking 100% index fund for him, because the bonds didn’t work our for me, and even my large cap growth fund didn’t do quite as well as the index fund (probably not helped by it’s relatively high management fees compared to the index fund).

2

Bonds are generally considered safer investments. With that reduced risk comes reduced returns. The advice to generally move towards safer investments (like bonds) as one approaches retirement is, I think, fundamentally sound.

ETA: and as for your young son, yes, I’d advise him to just throw it all in a whole-market index fund and leave it alone for the next few decades.

3

This, in a nutshell. Bonds make less money, but since they’re based on the US government “paying” its bills, they’re all but guaranteed to keep growing, thus they give very low return. Stocks give a much higher yield, on average, but they’re not safe. It IS possible to lose most or all of your investment, especially if the market crashes a la 2008 - just ask all of the hopeful retirees from the time who couldn’t retire because all of their savings were wiped out.

Generic advice is to start aggressive when you’re young, and become more conservative as time goes on. Under 35-40, you still have time to recover if everything is wiped out. At 60, not so much.

Rebalancing your account essentially “locks in” the gains you’ve already made. By moving some money from stocks to bonds, you protect your investments from huge market downturns, at the cost of losing some of the power of compounding returns. It also goes the other way - if the stock market takes a massive crap, rebalancing helps you get back in at the bottom of the trough. Basically, it cuts the tops and bottoms off of the stock market roller coaster ride.

4

Your bonds have underperformed your equities since we’ve had such a hot equities market over the past 7 - 9 years. If you rebalance consider it profit taking. If and when the economy crashes, you’ll be happy you did.
The idea is to decide what total level of risk you want up front, and then invest to meet it, and rebalance to keep that level until your risk profile changes, like getting close to retirement. Your son’s is different from yours which is different from mine.

This has worked well for me. It made me buy equities during the recession which has paid off nicely.

BTW, you might want to roll over your 401(K) into an IRA. No tax issues and you will have better control of it.

5

I’ve heard this before, but in what way will I have “better control of it”? While I can’t add money to the account, I can do whatever else I want with it (such as rebalancing).

As far as I can tell, my former employer pays the fees to maintain the plan with Fidelity. Why shouldn’t I let them keep doing this for me?

6

The advice you’ve gotten above is pretty much exactly what I would have said. Although, I would question your use of the term “index fund.” You seem to imply that it is a stock (or “equity”) index fund. But there are also bond index funds. You should avoid those during the early and middle part of your working life. They grow too slowly. Stick with stocks, be they index funds or other types of diversified mutual funds.

7

Right, when I referred to index funds above, I was referring to an equity index fund, like the Fidelity® 500 Index Fund.

So let’s see, I’ve been working for 28 years now. I’ve hopefully got 17-20 years more to work before I retire, assuming I stay healthy and employed.

Should I keep some of my portfolio in bonds (currently 12% of the account in question), increase the bond percentage, or decrease it?

8

I think you are fine, but be prepared to see big drops in your account. I did - in 2000-2002 I lost 41% and in 2008-2009, 46%.

I let it ride and kept investing - it came back. Since 2009 (when I stopped working at 60) my retirement account has tripled.

If I had known what I know now when I was your son’s age, I would have:

[ol]
[li]Invested aggressively - 90-100% stock index funds[/li][li]Maxed out my 401k[/li][li]Maxed out a Roth IRA[/li][/ol]

Had I done that I could have retired at 50.

9

II

I have a fidelity account. I changed from a 401k to a self directed IRA. I don’t recall any cost in doing so.

10

OK, so it didn’t cost anything to switch, but what are the advantages in doing so?

The reason I’m asking is because I’ve been told for the last decade that I can switch my old 401(k) to an IRA, but I have yet to hear a reason why I would want to do this.

11

Right, I went through the big drop in 2008-2009 as well. I didn’t touch anything, and it came back. The bond portion was much less volatile, of course.

I’m leaning towards advising my son to invest 10% of his pre-tax income in an equity index fund. I’d like to get him set up now, so he doesn’t miss the income.

12

Most 401Ks have a limited number of investment options. If you move it to an IRA, you are no longer limited. That’s going to be especially useful when you get older and start moving stuff to things which produce more income.

13

The old 401(k) likely had a very limited selection of funds that you had to select from. Moving to an IRA and you will be able to select from just about any mutual fund, ETF, or even individual stocks or bonds.

So why would you do it? You need to look at the expense ratios that you are currently paying on your funds (and yes, these are paid by you, not your previous employer). These fees can really eat into your returns, and since you have a long timeframe (17-20 years) you should move into a fund with low expense ratios. Do you know what fees you are paying in your current 401(k)?

14

To clarify the fee. It sounds as if your previous employer is paying the fee to the company managing the plan, which pays for bookkeeping, managing records, mailing statements, etc. But the funds themselves also charge a fee in the form of an expense ratio, and these come directly from your returns. You won’t see a line item in your statement that shows these fees being deducted because they take them out from the investment returns. So you won’t notice them slowly bleeding you.

15

My 401(k) is through Fidelity, so there seems to be a pretty broad choice of investment fund options (none of which are ETFs or individual stocks and bonds, but I wouldn’t likely be investing in those anyway). Regardless, the selection isn’t so much an issue with me, as I tend to get paralyzed with too many choices, anyway.

Yes, I believe so. They are as follows:
[ul]
[li]Fidelity® 500 Index Fund: 0.015%[/li][li]JPMorgan U.S. Research Enhanced Equity Fund Class L: 0.44%[/li][li]Fidelity® Intermediate Bond Fund: 0.45%[/li][/ul]

I presume the fees for each individual fund (which are a percentage of your returns) are similar whether you have a 401(k) or an IRA. However, if I were to switch to an IRA, is there a fee I would then have to pay to cover managing the plan, bookkeeping, etc.?

To attempt to answer my own question, it appears the answer is that these fees range from minimal to zero.

https://www.magnifymoney.com/blog/life-events/3-best-low-fee-ira-providers/

If I were to stick with Fidelity, the account maintenance fee is apparently zero. There do seem to be transaction fees for some non-Fidelity funds.

16

OK, thanks. That makes sense.

Out of curiosity, what types of things are those?

Also, it sounds like I don’t need to worry about these things for now, so if I’m OK with my current investment choices, I presume I can make the switch at some point in the future?

17

One reason to avoid having an IRA has to do with a strategy called a ‘backdoor Roth’. Before you commit to having an IRA, make sure you wouldn’t ever want to do a ‘backdoor Roth’.

18

That is an excellent idea - but I would challenge him to shoot for 15% - eventually. As I said, max out the 401k then a Roth. My biggest regret is that I ignored the Roth advantages for too long.

Also point out that the power of compounding means that investing for ten years from 25-35 beats starting at 35 and continuing until 65. Of course, 25-65 is even better as is starting before 25.

19

Those fees don’t look outrageous. But a very quick glance at the JPMorgan U.S. Research Enhanced Equity Fund looks like it’s not substantially different than the S&P 500. It invests in large cap stocks, which is the same asset class as the S&P 500, and it probably doesn’t perform much differently than the S&P 500 (it appears to very slightly underperform), yet the fee is 29 times the fee of the Fidelity 500 index fund. If it’s not substantially different, why pay 29 times more than you have to?

Your real issue appears to be asset allocation, and Fidelity stating that you should have 15% rather than 12% in bonds is somewhat trivial compared to the fact that you don’t have any exposure to mid and small cap stocks, but own two funds that have pretty much the same thing in large cap funds. I suggest you spend the next few weeks or so learning what you can about asset allocation, determine what is right for you, and then see what funds are available that you can buy that will give you the allocation you want. I know you said you tend to get paralyzed with too many choices, but knowing what it is you want will go a long way towards overcoming that.

20

When I was your age I was invested kind of like you are now.
There are certain classes of stocks, and funds that contain them, which consist of stocks paying reasonable dividends in unexciting sectors. I have one income fund which is making 5% relative to what I put into it, 3% relative to what it is worth now. So yield goes down with a rising market, and I’d guess up in a falling market. The good thing is that if these investments generate enough cash for you to live on (plus Social Security etc.) you don’t care what the market value is.
They have names like Income Fund. I suspect Fidelity has them when the time comes.