Let Me Clarify

Whether you are just beginning your first full-time job or are in the later stages of your career, you are not alone if you have questions about your company’s retirement plan and the investment options within the plan.

Having a background in financial education, spending years helping employees of a variety of companies understand their employer benefits and the planning around them, I certainly understand the confusion (and the lack of resources) surrounding 401(k), 403(b), 457, and other plans that you may be investing in through work. Specifically, when it comes to the investment options, you are usually provided with a list of funds to choose from and then seem to be on your own.

I do think that companies have come a long way and are continuing to improve upon adding resources to aid in planning for retirement, but there is still much work to be done. In the meantime, let us walk through how to digest the options you have available and set a foundation for narrowing down the investments that may be a good fit for your situation.

Are you a “hands-on” or “hands-off” investor?

This is always one of the first questions that I ask someone who is managing his or her own investments. When I ask this question, I am asking for a bit of honest self-reflection on how comfortable you are when it comes to researching and picking individual investments, choosing your allocation percentages, periodically rebalancing your account, etc. This question alone can substantially narrow down which investment options to consider and which to ignore.

There really is no right or wrong answer to the question above and investors can be successful utilizing either style, so please do not approach it with any preconceived notions. The key here is being sure to avoid any situation where you may not be prepared to determine appropriate allocations, rebalance, etc. which would likely be the cause of the bulk of any long-term performance differences.

Hands-off investing:

Like many people, you may be asking “will I have lower performance if I choose to be hands-off?” Studies show that when comparing long-term investment performance (assuming similar allocations and proper management) there really is not a significant difference for the average investor. That being said, the major benefit to this approach is that your investments are basically on autopilot through target-date or allocation funds.

Target-date and allocation funds are similar in that each fund is made up of cash, bonds, stocks (both international and domestic), and often other asset classes such as real estate, commodities, and more. So, with diversification being a huge part of investing, choosing one of these funds means you are already diversified within it; much different than if you were invested in only one stock or bond mutual fund.

The main difference between these fund types is that allocation funds rebalance to the same allocation indefinitely, while target-date funds rebalance and reduce risk over time. For example:

• An allocation fund that is 80% stocks/20% bonds today will still be roughly 80% stocks/20% bonds 10 years from now.
• A target-date fund that is 80% stocks/20% bonds today will likely be closer to 60% stocks/40% bonds 10 years from now with risk reduction as an added layer of management strategy.

Once the hands-off investor has determined an appropriate portfolio allocation based on his or her personal risk tolerance, the remaining step is identifying the target-date or allocation fund that matches most closely (based on its underlying holdings). From there it is on autopilot and should be re-evaluated periodically or when circumstances change.

Hands-on investing:

As a hands-on investor, assuming you have already determined an appropriate risk tolerance and desired portfolio allocation, the next step is narrowing down the list of mutual funds that are available to you. Your plan should already classify these funds by asset class (large cap, small cap, international, emerging, bonds, real estate, etc.).

If you work for a company that provides a generous list of options in each category, I suggest starting with narrowing down your search based on active vs. passive funds.

• Passive funds are typically lower-cost and simply attempt to mimic the performance of the index that it follows. For example, a passive large company stock fund may seek to achieve the same exact performance as the S&P 500 index.
• Active funds cost a bit more and invest in a fraction of the companies within a particular index in an attempt to choose those that will outperform the broad index as a whole.

For reference, historically there has not been any significant difference in performance between the two. However, that does not mean that history will always repeat itself and that active funds will not underperform or outperform from time to time.

In addition to active and passive, you will want to factor in expense ratios (the annual fee for each fund) and may want to familiarize yourself with growth vs. value and other distinctions within each asset class.

Regardless of which approach you choose to take, keep in mind that one of the first steps with investing is figuring out your personal risk tolerance and the appropriate allocation for that risk level. Once you have determined your investing destination, hopefully this can serve as a bit of a roadmap to guide you there.

Remember, every plan and its investment lineup are unique; as well as each of your personal situations. So, if you find yourself with more questions, please let us know how me might be able to help.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendation for any individual. This information is not intended to be a substitute for individualized legal advice. Please consult your legal advisor regarding your specific situation. Clarify Wealth Management and LPL Financial do not provide legal advice or services. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All investing involves risk including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. Rebalancing a portfolio may cause investors to incur tax liabilities and/or transaction costs and does not assure a profit or protect against a loss.