I’m sure you’ve already been told many, many times how important it is to invest in a 401k if you have one available to you. So while we’re going to spend some time in this article reiterating that, we’re mostly going to talk about what to do with the money once it’s in your 401k. Because, after all, while actually investing in a 401k in the first place is the most important thing, what you do with the money invested there is almost as important.

One of the top concerns that clients come to us with is that they may not be properly investing the funds in their employer plans. For clients of Personal Capital, we actually offer personalized reviews of your 401k, and we can give you asset allocation and fund selection recommendations based on your specific plan. 

All 401k plans are different, so the best way to get personal advice on your specific situation is to talk to an advisor, but today we’ll cover our general philosophy when it comes to asset allocation and fund selection to give you some insight into the method behind our recommendations.

Take Advantage of Any Employer Match

The answer to this question really depends on your personal situation, but in general, you should be contributing as much as you can. If you have extenuating circumstances like large amounts of high-interest debt, we’d recommend consulting a financial advisor on where your 401k contributions fit into your larger financial plan. The annual 401k contribution limit is $19,500 for 2020, which increased from $19,000 per year in 2019. Contributions to 401k plans are made with pre-tax dollars (for traditional 401ks), which means that your money will grow tax-free until you start to tap the funds in retirement. And that is super powerful. To see how compounding interest can impact your retirement savings over time, check out our article on the Average 401k Balance by Age here.

If you are not able to save up to the annual limit, make sure you are at least saving the amount of your employer match (if there is one available to you). If you don’t contribute at least enough to get your full match, you’re leaving money on the table. It’s the same as ripping up a few paychecks every year!

Successful Asset Allocation in Your 401k

So now that we’ve established why it’s important to contribute as much as possible to your 401k, let’s dive into how to invest that money. The biggest thing to establish when it comes to investing and managing your 401k is your asset allocation strategy. Your 401k is part of your net worth and overall retirement plan and portfolio, so broadly speaking, your strategy for your 401k should match your overall investing strategy.

The key to selecting an appropriate asset allocation is determining the goals for the assets, the time horizon for those goals, and your risk tolerance. So if all those factors align between your 401k and your overall investment portfolio, then the asset allocation should be very similar between the two portfolios. However, if one of those factors is very different (for example: the time horizon for the 401k is much longer than that of a taxable account), then that would require a deeper conversation with a financial advisor to determine what is actually appropriate.

To learn more about how to determine the right asset allocation for you, read our article “Getting Ahead of the Curve with Asset Allocation.” To learn more about Personal Capital’s approach to asset allocation for our client’s portfolios, read about our Investment Methodology here.

How to Make Fund Selections in Your 401k

What’s most important for your 401k is having the right asset allocation, but the fund selection obviously matters too. The main thing we consider when making fund recommendations for clients is fees.

Most 401ks will have some nice low-cost index fund options, but they also often have high-cost mutual funds, so it’s important to look out for those and select the lowest cost, most broadly diversified funds available in your plan.

There are also some situations where the target date fund is a perfectly fine option, depending on the breadth and cost of the other options available to you. As a quick refresher: target-date funds are designed to give you a single, simple investment vehicle. They usually operate under an asset allocation formula that is based on what age you plan to retire. If your plan doesn’t offer a range of good, low-cost index funds to choose from, sometimes the target date fund is actually the best way to go. However, not all target-date funds are created equal, so we really encourage you to talk to an advisor before making this selection.

What to Do With an Old 401k

Now that we’ve talked about why it’s important to max out your 401k and given some rules of thumb around managing it, let’s talk about what to do if you have an old 401k.

You have a few options available to you. However, we really don’t recommend keeping any assets in your old plan — you’re no longer getting the match, and most likely there are better investment vehicles out there. We also don’t usually recommend cashing out any portion of your 401k if you are younger than 59 ½ — those 10% penalties and taxation mean it’s rarely a good idea.

We generally think that the best thing to do with an old 401k is to roll assets over into an IRA. There are several reasons for this, but the main reasons are the potential for:

• Lower fees
• More investment options
• Increased withdrawal flexibility
• Easy to execute

To learn more about rolling over your 401k, read our article “The 401k Rollover: Is it Right For You?”

So, except in the case that you own company stock in your 401k or need access to your funds immediately, it’s typically best practice to roll your 401k into an IRA. Make sure you talk to a financial advisor before executing a rollover IRA, though, because everyone’s situation is unique and there are always exceptions.

Our Take

To recap, the most important actions to take now for successful 401k management are:

1. Make sure you are contributing as much as you can afford to your 401k or at least taking full advantage of any employer match.
2. If you are a Personal Capital client and you haven’t already, schedule a time with a Personal Capital advisor for custom recommendations on asset allocation and fund selection within your specific 401k plan.
3. If you have an old 401k, the best option is likely rolling the assets over into an IRA.

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