How to Choose a 401k Mutual Fund
Choosing a mutual fund in a 401k is similar to selecting a fund outside of one. There are a couple of differences, however. First, because a 401k is a tax-sheltered plan, there's no need to be concerned about taxes on dividends or capital gains distributions. Next, depending on your age, 401k assets aren't generally going to be available until you reach retirement age --- which means you may wish to make a selection based on that time frame.
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Things You'll Need
- 401k plan information
- Mutual fund prospectus
- Access to mutual fund reviews/ratings
Instructions
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Review and Selection
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1
Review the plan summary. This information should give an overview of plan features, such as matching contributions and contribution limits.
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2
Familiarize yourself with the plan's investment electives. 401ks are required to offer at least three elections: 1) stable value funds, 2) fixed-income/bond funds, and 3) equities/stock funds for long-term growth of principal. Plans usually offer multiple investment choices --- sometimes a dozen or more --- encompassing all three classes of securities mentioned above. These can be more asset class-specific. Examples may be a stock fund that invests only overseas, or a bond fund that only invests in short-term government bonds.
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3
Read any plan literature that describes how investors with different goals, risk tolerances and time horizons could typically invest --- and with what types of funds --- and how these funds may tend to perform.
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4
Understand how volatility and returns are correlated. Your plan literature must include this information. More-volatile funds tend to offer greater returns, but the value fluctuates much more than with a stable value fund that guarantees a certain but smaller amount. An investor with five to 10 years until retirement likely needs to be more conservative --- emphasizing more income and stability than growth, even though an element of growth should still be incorporated. On the other hand, a younger participant can assume more-volatile funds to accumulate more wealth over a longer period of time.
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5
Identify which funds in the plan can meet your objectives. If you're more growth-oriented, isolate the growth funds for further review.
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6
Read the prospectuses for the funds you've isolated. Learn how the fund manager intends to select investments for the fund, what the fund operating expenses are --- and how they impact performance --- and whether there are any restrictions.
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7
Evaluate the fund performance. This information may be available in the literature provided by the plan, but more detailed information can be sought online through sources such as Yahoo! Finance or Morningstar. Morningstar is a subscription-based service, but Yahoo! incorporates Morningstar's rating and ranking systems.
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Contact the plan administrator by phone or use the plan's online interface to make your fund selections. You're able to allocate existing balances by dollar amount and/or allocate new contributions by percentages.
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Tips & Warnings
Monitor your plan balance periodically over time. It's important to not get caught up in the short-term gyrations of the individual mutual fund position's value. On the other hand, if you're nearing retirement and you find the volatility too troubling, adjusting balances and contributions toward a more conservative fund may be warranted.
