Go Fish

Adam M. Grossman

WHEN AN INVENTOR goes on record stating that his invention is “a monster” that he’d like to “blow up,” you know there’s a problem.

Such is the case with Ted Benna, who back in 1980 created the first 401(k) retirement plan. Since then, his invention has grown to become the dominant retirement vehicle for millions of Americans.

Why is Benna so negative on his creation? The problem, in a word: complexity. According to Benna, the first 401(k)s were a model of simplicity. They offered just two investment options, a stock fund and a bond fund, and they were offered in fixed percentages. That meant that workers needed only to choose from a total of five possible combinations (0% stock/100% bond, 25% stock/75% bond, and so on).

Today, by contrast, the typical 401(k) menu offers nearly 20 fund choices—and without the restriction of fixed percentages. As a result, the possible combinations of funds and percentages is astronomically large.

Trying to choose investments for your own 401(k)? I suggest the following three-step process to cut through that complexity:

Step 1: Opt for the easy choice. Today, many employers offer target-date funds. The key advantage of these all-in-one funds is that they adjust automatically to your age, becoming more conservative as you get older. They aren’t perfect—age, after all, isn’t the only determinant of one’s needs—but they are far better than an arbitrary selection of funds. If your company offers a target-date fund, that’s an easy choice. Just be sure to select your target date carefully, so it matches your retirement timetable. If your company doesn’t offer a target-date option, proceed to Step 2.

Step 2: Fish in the right pond. Your 401(k) menu may be long, but it’s important to know that most funds fall into just a few basic categories, such as stocks and bonds. While you want to make the best choice within each of those categories, research has shown that the category itself drives 90% or more of your results. In other words, if you fish in the right pond, that’s much more than half the battle. You might want some help with this process, but the basic idea is to allocate your portfolio to stocks when you are young and then slowly incorporate bonds as you get older.

Step 3: Cast a wide net. Once you’ve decided which types of funds you need, you have to choose specific funds. Here, the key is to go for funds that offer broad diversification at low cost. To continue the fishing analogy, once you’re in the right pond, just cast a wide net. The easiest way to accomplish that is with index funds. The data clearly show that this approach offers the best odds for success.

Anyone who has ever struggled through a 401(k) menu can sympathize with Ted Benna’s frustration. But, by following the three steps above, I believe you can significantly simplify the process.

Adam M. Grossman’s previous articles include Site Seeing (Part III), Footing the Bill and Trust Issues. Adam is the founder of Mayport Wealth Management, a fixed-fee financial planning firm in Boston. He’s an advocate of evidence-based investing and is on a mission to lower the cost of investment advice for consumers.

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