A Three-Step Exercise to Help Evaluate Your Options

Private employers in the United States provided access to retirement benefits for 66 percent of the workforce in 2015, and an even greater percentage of public sector workers were provided access to retirement benefits. Despite this access, less than half of private sector workers actually participated in a plan. Why is this? One reason is simply not knowing where to start. The plethora of options, stars, performance charts and financial jargon is enough to make some people just give up. Cutting through all of this information, though, can be achieved by putting the investment choices through a three-part process.

Let’s start:
1. Mix
Before even looking at the specific investment options, you should determine the types of investments you should be looking for. Types of investments, also called asset classes, can broadly be broken down into two categories: equities (stock market exposure) and fixed-income (bond market exposure). A third important asset class that’s not often discussed is cash. For any portion of your plan that you’d prefer not be risked at all, cash is your best option. Keep in mind, though, that for the portion of your plan you choose to put in cash you are forgoing not just the potential downside of investment losses, but also the potential upside of investment appreciation. Are there other categories? Yes.

Do you need to worry about them? Likely not. Let’s keep it simple for now.

Your non-cash investment mix should be determined primarily by two things: how long it will be before you plan on needing the money (time horizon) and your ability to stomach fluctuations in account values (risk tolerance).

A longer time horizon or higher risk tolerance would dictate a higher allocation to equities. Conversely, a shorter time horizon or lower risk tolerance would dictate a higher allocation to fixed-income. Not sure where to start? Start at 50-50 then ask yourself—is it going to be more than 10 years before I use the money? If the answer is yes, up your equity exposure. If the answer is no, up your fixed-income exposure. Now ask yourself—will I lose sleep over a 10% account value decline? If the answer is yes, up your fixed-income exposure.
If the answer is no, up your equity exposure. For simplicity’s sake, do this in
25 percent increments for the answer to each of these questions. Your resulting asset allocation may look something like this:
screen-shot-2016-11-27-at-5-52-16-pm

Remember, this is a sample allocation for the invested portion of your account so any cash allocation isn’t illustrated.

2. Cost
So you’ve determined your asset allocation (again, mix of stock market exposure vs. bond market exposure), now what? Pick your fund in each category. That’s right, one fund. How? Pick the cheapest option. Come again? Look at something called the expense ratio for each fund. This is simply a measure of how much in fees the fund company is charging you on an annual basis. Now, pick the fund with the lowest expense ratio. Done. Why, you ask, would this help pick the best fund? Simply stated—costs eat into investment returns. Additionally, lower-cost funds tend to be passively-managed index funds that simply track, after expenses, stock market performance. Over the long-run very few active managers continuously achieve higher-than-market returns after costs. One of the simplest ways to find the funds that will likely do relatively better over time in your retirement plan is to find the funds that are going to charge you less money over time. This isn’t always the case, but it usually points you in the right direction.

3. Advice
Rules of thumb and sample allocations like those in the chart above can be a useful starting point, but finance articles should never be the end-all and be-all of your investment decisions. Other considerations that would affect what your plan investments should look like include your savings and investments outside of your workplace retirement plan, what your pensions and social security benefits will be, your tax bracket, your health, and your goals for the future. To make sure that all of these factors are considered properly, seek a qualified professional opinion.

Sources: http://www.bls.gov/news.release/pdf/ebs2.pdf – Bureau of Labor Statistics
https://advisors.vanguard.com/iwe/pdf/FASIPC.pdf – Vanguard Advisor Services
Disclaimer: This article is generalized in nature and should not be considered personalized financial, legal, or tax advice. All information and ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation.


By John N. Hall, CFP®

Lynchburg Restaurant Week 937w