Bridget Sullivan Mermel CFP(R) CPA
How to Pick Investments for My 401K? | We reveal how we invest our 401Ks
Figuring out how to pick investments for your 401K can be confusing. We tell you how we chose mutual funds in our own 401ks, what our thinking is behind how we do it, and give you suggestions on how to make it easy on yourself.
When looking at the list of mutual funds:
Look for index funds.
If you're investing yourself, target date funds can be attractive.
In general, you want a well diversified portfolio with low expense ratios.
If you're older and have other investments, it can make sense to focus on bonds in your 401K to create a tax smart portfolio.
This may seem disappointingly simple. It's often okay if you haven't invested your 401K in a lot of different mutual funds.
Here's the article I talk about--how Jim Cramer invests now. Hint--it's not what he recommends on his show!
We talk about how we invest and why we invest the same way ourselves as we do for our clients.
00:00 Welcome 00:47 What John does with his 401K
01:51 What Bridget does with her 401K
02:34 Brief explanation of asset class and investing based on asset location
03:02 Bridget’s first 401K
05:07 Common client mistake
05:55 More discussion of Target Date funds
07:31 Why it makes sense for Bridget to have most of her 401K in a bond fund
08:05 Why it’s tax smart for Bridget to invest that way
08:25 What if there aren’t index funds?
Here's Bridget's firm website: www.sullivanmermel.com
John's firm website: www.trinfin.com
For advisors around the US: www.acplanners.org
Thanks for watching and please subscribe!
John: Have you ever wondered how financial advisors invest their own 401Ks? We're going to let you take a peek behind the curtain in today's episode of Friends Talk Financial Planning. Hi, I'm John Scherer, and I run a fee-only financial planning practice in Middleton, Wisconsin.
Bridget: And I'm Bridget Sullivan Mermel. And I run a fee-only financial planning practice in Chicago, Illinois. John, before we go further on 401Ks, let's remind people to subscribe. It helps our channel. It helps us stay motivated to keep offering great content for people and help people out. So 401Ks. Do you want to tell me about them? Let's cut to the chase, and then I'll tell you my story.
John: Yeah, I thought that it was interesting to think about what we do. We tell other people what to do with these things, but what do we do? The sort of spoiler alert is I do the same thing that I tell my clients to do. And what that is, is look for index funds, if possible, try to have tax location, try to keep things like our bonds and things that aren't tax efficient inside the 401Ks.
And really, those are the two big things. It's surprisingly, perhaps disappointingly simple. But that's what works in real life. I think maybe one thing that's interesting is that you hear other folks say, “We tell you to invest here, but here's what we really invest in.” For example, money managers that run mutual funds, who say, “We do this, but then in our personal portfolio, we do that.” That's not what happens for me. What works, works. So that's my takeaway.
Bridget: Yeah. An article recently about a famous money person who was talking about how they're retiring and what they're really doing with their money is quite a different story than what they promoted on their television show.
John: Yeah. Interesting.
Bridget: It was interesting, and I think people are curious. So again, I tell people that when we're looking at portfolios look at the expense ratios and what the expense ratios are going to be. And this isn't coming from, Bridget, this is coming from Nobel Prize winning research that the biggest factor in success between mutual funds is the expense ratios.
And then the other thing you want to make sure is that you are diversified. So, I think, let's look at this in 401Ks and ask, “What are the expense ratios?” Because that's what is legitimate to judge mutual funds by. So just look at the expense ratios. What's the lowest and what's in the asset class that you want.” So you've got US, international, and bonds.
Now, when I look at somebody's entire portfolio, I'll oftentimes have fixed income or bonds more than 401K because of being tax smart, which is a little bit beyond the scope of our topic today. But being tax smart says, “Okay, if they've got to go somewhere, let's put them in the 401K.” So, that's the other thing. Now I can tell my story about when I started with my first 401K.
John: I love it! Because you weren't financial advisor, right?
Bridget: Right. I was not a financial advisor, but I worked in a derivatives firm. I was in the accounting department of a derivatives house, and I started investing in a 401K. And this was in the early 90s. And so, although I had a degree in accounting, I had taken one class in finance. Mutual funds were really coming of age right at that point, so I was not that familiar with them. And so, I looked at the list, and first, I was starting small with my first investments.
So, it's one of those things where I said, “If I make a mistake, it will be okay.”
So anyway, I thought, “I'm going to get going here.” So I looked at the list, and this was before they, at least according to my memory, had target date funds, because now a good Vanguard target date fund would be what I recommend for somebody that's just starting out in a 401K. But they didn't have that, so I looked at the list, and I just looked at the names, and I thought, “Balanced fund. That sounds good. I like balance. I'm all about balance.” So, I invested in a balanced fund. Okay. Works fine. I had that for about a year.
Then I was in the accounting department, and I had to work on an audit. So part of the audit was asking people to confirm what they had in the 401Ks. And so, I had to send out these letters. And so, I got a peek inside what the partners, et cetera, had in their 401Ks. And what was it? Vanguard Index Fund. I thought, “Vanguard Index 500. That sounds pretty boring, but that's what they're doing. I guess I'll look into that and do that.” And so that was my first step into just using index funds in my 401K.
John: I love that story. You have to see what people are doing to say, “Hey, wait a minute.” One of the things that we see when clients come in is that some of these 401K plans are very overwhelming. They've got two sheets of paper with all the funds, I mean, 100 funds. And you might think, “Isn't that great? You got a choice.” Well, it also gets confusing. What do you do?
And one thing that I think is important to note is that you don't need to analyze every opportunity that's out there. It kind of goes back to that idea of when you swing the bat, make sure you get a hit sort of thing. We can look through that and go, “Okay, do they have an index fund? And is it S & P 500? Maybe they've got an international one. What are the different choices?”
And I don't need to analyze every one of those funds, but I look at the expense ratios. Is it an index fund? Golly, that cuts out most of them. Now we got a good menu of things. And I'm glad you brought up the target date funds. I think that's a great thing. It gives you a mix of stocks and bonds. And again, when you're just starting out, it’s a great option. Maybe when you have enough zeros in the portfolio, you want to do something different. But for most people to stock that money away and let it grow is the best option.
There's one mistake that I sometimes see people making, and I've thought about it on my own, and I try to avoid it. It is when you have a balanced fund or a target date fund, that's great. But then sometimes we'll have a balanced or target date fund, and then we'll also have this fund and also have that fun. And you're throwing off that balance. You're throwing off that target. And even though it feels like, “Jeez, I'm going to put all my retirement money into one fund.”
When you open the hood on that one fund, there're thousands and thousands of different stocks and it is actually diversified in there, even though it might not feel like it. So what we don't do in 401Ks for employees is have one of those target date funds and some other funds because it throws off what you're trying to accomplish.
Bridget: Yeah. And I would also say that don't be afraid of the simple, but elegant portfolio in your 401K, particularly. You don't need a lot of flourishes. Just simple and elegant is what I go for with 401K investing. I know it's in there. I know it's decent. I know what the purpose of it is in this portfolio. I'm calling it a day. And I don't overthink it.
John: And I know in my personal 401K, I have either three or four funds. That's it. And not the laundry list of things; it’s just simple.
Bridget: And mine personally is mainly invested in bond funds. In my situation, we get to actually set up our 401K, so that gives us a lot more flexibility. Most people don't have that privilege, but that's what I have. I've got it in a bond fund, but that's because I've got other investments in other accounts that are not in my 401K that are invested more aggressively. My 401K is going to end up being taxed more when I take the money out. So if it grows a little bit slower and other parts of my portfolio that are going to grow faster, grow bigger, then that's great. That's how I do it. So that's a little bit of that tax strategy.
John: That's maybe a great place to circle back and sum things up. It doesn't have to be complicated.
John: Keep costs low. Look at index funds. And one thing we didn't bring up was what happens if there aren't index funds? As you described, though, if there's no index funds, it's usually those other funds that are low cost. That doesn’t necessarily guarantee they’re great funds, but it gives you the best chance at success. So, keep it simple and keep it inexpensive.
Bridget: And don't be afraid of the process of elimination. You can just eliminate a lot of them without doing tons of research or feeling bad about not doing lots of research.
John: Right. And if you've got one of those target date funds, that's probably a pretty good choice, or at least a good place to start as you think about that. Well, with that I'm John Scherer, and I run a fee-only financial planning practice in Middleton, Wisconsin.
And I’m with Bridget Sullivan Mermel, who runs a practice down in Chicago, Illinois. Bridget and I are both members of the Alliance of Comprehensive Planners. So if you like what you hear and some of the concepts on our show, check out acplanners.org to find an advisor in your area.
Bridget: And don't forget to subscribe.
John: That’s right!
Bridget: Subscribe to our show. It helps us out and it helps more people hear about us, so we really appreciate it.
John: That's great.
Bridget: And with that, we'll wrap it up.
John: Until next time.
Bridget: See you next time.
At Sullivan Mermel, Inc., we are fee-only financial planners located in Chicago, Illinois serving clients in Chicago and throughout the nation. We meet both in-person in our Chicago office and virtually through video conferencing and secure file transfer.