Retirement Chat: Your 401(k) Investment Mix

In this episode of Retirement Chat, we'll highlight some of the most common questions we receive about how to get the right investment mix in your 401(k) account. This can depend on your age and investment timeline, your risk tolerance, and whether you want to be a hands-off, set-it-and-forget-it investor or take a more active role in selecting your investments.

Welcome to Union Bank and Trust Retirement Chat, a series of conversations designed to answer your retirement savings questions and help you reach the retirement you envision. We have our experts with us, so let's chat.

 

Caitlin (host)

Hey, it's Caitlin again. I am one of the retirement educators here at UBT, and today we're going to be talking about investing specifically in your retirement account. And today we have Joe Recker with us. He's one of our investment officers here at UBT, and he's been with the bank for almost eight years. So thanks for being with us, Joe.

Joe

Yeah, thanks for having me, Caitlin.

Caitlin

As an educator, investments can be one of the most confusing pieces of the puzzle, and we get a lot of phone calls and meet with a lot of people that have questions about their retirement investments. And for younger folks, this can be their first exposure to investing altogether. So I want to ask a couple questions that we get frequently because you're the expert today. So to start with, in our investment lineups here at UBT, we have money markets or stable values, bonds, mutual funds. So can you tell us the difference between these and even explain through what a target date fund is?

Joe

Sure, yeah. So just starting with the money market and stable value, I'll kind of just lump those together. So typically in a 401(k) lineup, those are going to be the most conservative options for an investor. A money market, essentially, that's just a fund that invests in short-term debt securities like US Treasury bills, super conservative. Those would be, those instruments would be guaranteed by the US government. There's not a lot of risk involved in those, in a stable value that is a collection of bonds that is insured by an insurance company, essentially that, so that's how they create that stable value based on those bond coupon rates. The insurer essentially guarantees a rate of return for a certain period, usually a quarter at a time. And so those are your most conservative options. So typically for a younger investor, that's not really where you want to park most of your money.

<Affirmative>

Because with less risk, you know, there's less potential for return with those funds. So you're going to want to look at the other mutual funds or the target date funds in your investment lineup. Just to answer your, the rest of your question, so there's different mutual funds. There are going to be bond funds and there are going to be stock funds. So any bond fund that's going to have within those, there's going to be individual bonds. So debt securities that represent borrowing of money from companies. Those are, again, those are going to be on your more conservative option. There's less volatility with bonds, less risk than there is with stock investing. So then there's the, the stock mutual funds, those are going to have stocks in there, which are ownership stakes in individual companies, which again, those are going to move up and down.

There's going to be a lot more volatility than those bond funds. And so what if, then, just to break it down even further, what's a mutual fund? So that's essentially, that's just a, just a pool of money from many investors that invest in securities, you know, such as those stock and bond funds. So that's different than investing in individual stocks and bonds, whereas there's that pool of money together, which there's going to be more diversification, within those funds, and there therefore there's less risk. So if one of those underlying investments performs not quite as good or fails, essentially, there's a lot more holdings within those funds so that there won't be as much ups and downs within the total account balance. So essentially it's, a little bit, I don't want to say safer, but there's less volatility typically with mutual funds than there could be with individual stocks and bonds.

Caitlin

So I guess that goes into another question then — why don't we have individual funds in our lineup? Why do we keep it with mutual funds?

Joe

The 401(k) lineups are built for the average investor. So for me, for somebody that's going to invest in individual stocks, that would be for a more sophisticated investor. And so you would typically do that outside of your 401(k) because if you invest in, put all your money in one company and that company fails, you know, you theoretically could have unlimited losses. You could lose all your money. So that's why our 401(k)s have mutual funds. They can have collective trust that's kind of similar to a mutual fund, but that way if one of those companies fails, then you won't lose all your money in those instances. So that's reserved for more sophisticated investors.

Caitlin

Gotcha. So if somebody is interested in investing in individual stocks, the 401(k) is not the right avenue for them?

Joe

Nope. You're going to want to open a broker's account or something outside of your 401(k).

Caitlin

OK, so why don't we have individual stocks or even exposure to things like precious metal, cryptocurrency, things like that?

Joe

Again, that's, that's reserved for more sophisticated investors. The average investor might not understand the risks associated with, you know, certain precious metals or, or crypto or individual stocks. And so they might make an uneducated decision by putting maybe too much of their money and not understanding those risks involved, and so we, you know, the 401(k) lineup’s designed for you to, you know, not be able to take those sort of risks as an average investor that may not be a seasoned veteran in the investing world.

Caitlin

And I like to talk to people about longevity too with their retirement account, and I haven't heard you say that, but what I have heard you say in the past, and what we talk about a lot is, mutual funds are more targeted at long-term investing, which is essentially your 401(k). We're not, we're not investing for tomorrow, we're investing for 20, 30, 40 years down the road. Am I correct in saying that?

Joe

Absolutely, yeah. Mutual funds aren't designed for trying to time and market like day trading with those, they're designed to like a buy-and-hold strategy where you're just going to buy your mutual fund and then you're just going to essentially hold it, you know. You're still going to review your account periodically, annually, at least annually, you know, and then maybe make changes, rebalance, change your investment mix, you know, if your time horizon or risk or goals have changed. But typically you're not going to want to be trading those on a day-to-day basis. They're not designed for that.

Caitlin

Gotcha. Awesome. Well, one of the biggest questions that we get — and I talked to the educators so we all agreed on this one — but in terms of mutual funds, bonds, money market, or even the target date funds, which I want to go back and have you explain that really quick, but what are some of the pros and cons of either, so if you don't mind just explaining the target date fund and then just kind of talk about a mixed lineup of kind of pick your own bonds, mutual funds, or the target date funds.

Joe

Sure, yep. So just to start with, what is a target date fund? That's basically just a mutual fund; it invests based on a targeted future date. So when you have your target date, you'll have a collection of multiple target date funds, then they're going to have a year attached to them. So for example there'll be a 2020 fund, a 2030, 2040, 2050, 2060. Those dates represent essentially how that portfolio is managed based on that target retirement date. So a 2050 fund, that would be designed for somebody that's going to be retiring in the year 2050. So that's how that particular company invests that target date fund. So for younger investors, if you have more years to retirement, they're going to be more aggressive, which means they're going to have more stock exposure; more stock than bond exposure. And then how it works is, as that fund gets closer to that retirement date, each fund, each of those target day funds, has what's called a glide path.

And so that glide path will dictate how that mix changes over time, where it gets more conservative where the portfolio will add more bond exposure over time and reduce that stock exposure. And the purpose of that is to reduce that volatility because you don't have as much time to weather those ups and downs in the stock market as you would as a younger investor. So that's kind of the purpose of that; typically it shifts from being growth oriented to being more income oriented as you do get closer to retirement. Because when you're getting into those retirement years, it's more important for the portfolio to generate income than to generate growth. And usually there's less volatility with that, less risk for those investors.

Caitlin

So the target date funds are essentially a whole kind of package deal for you. You get a kind of a mixed bag of everything, but the younger you are, the more aggressive it's going to be, meaning a little bit more stock exposure, that direction. But the closer you get to retirement, the less aggressive, and it does it for you. It's kind of a set-it-and-forget-it type of thing. You never have to touch it again and it'll get you all the way to retirement should you choose to go that path.

Joe

Yep. and it is actually a fully diversified portfolio in one. Those targeted funds are typically going to have exposure to US equities, international equities, US bonds, international bonds, and so essentially, yeah, it's just a, it's a full portfolio in one. So it's actually, if you're not sure as an investor what to invest in, you're kind of new, a target date fund is a great way to go because you're going to let that target date company basically build a portfolio for you and manage it. They're going to do the rebalancing, they're going to do the essentially they're going to manage the risk for you as you're getting closer to that retirement age, so it's a great option for people. On the other hand, your investment menu is going to have individual mutual funds. They're going to have international funds, they're going to have bond funds, you're going to have US equity funds, and then that's going to range typically along the size spectrum, so there's going to be large-cap funds, mid-cap funds, small-cap funds, and then if you break it down even further, there's going to be value blended growth funds. And so typically if somebody that is sophisticated wants a different asset mix than those target date funds, then they can kind of build their own portfolio with those investments that are included on the menu.

So you know, if you want to be more aggressive than what that target date fund offers or if you want more of a certain one of those areas in your portfolio, then you can go ahead and build your own using those individual funds. And within those individual funds, there's going to be actively managed funds and there's going to be index funds. So actively managed would be, there's a professional management team, you know, making tactical moves based on different market conditions. Or you could just use an index fund where that fund is just trying to track an index. The most common one would be to track the S&P 500 index — that's kind of the most common one that people are familiar with.

Caitlin

Yeah. So it sounds like if you want to be involved in your investment choosing, you know, pick your own options is great because you can, you can get pretty specific without saying, “I want to buy this individual stock” because we don't have that. But you can be picky on what you want to get where the target date funds, you're kind of given a lineup, you're given a portfolio, but you can not touch it. You could be completely hands off and still be actively involved in the investments.

Joe

Yep, that's exactly right. That's kind of the, what you said exactly fits, is target date is for a hands-off investor. Picking those individual funds and building your own portfolio is more for the hands-on investor that's invested in it and really wants to learn about that, and wants to have their own stamp on their investments.

Caitlin

Yeah, so is there a right or wrong way?

Joe

No, really. I would say, don't invest in something you don't understand. And so if you don't understand, then I would say learn about the target date funds. Then you're just learning about one thing. And so there's really not a right or wrong way, but I would say just understand what you're investing in. If you don't understand what those different mutual funds in your menu are, you know, what the risks are, what the different styles of investing are, then I would say don't try to build your own portfolio unless you take the time and learn about that. But the target date funds are a great option, you know, if you're just getting started or you're just not sure.

Caitlin

Yeah, and, and that's something I like to tell people is, if you haven't done your homework yet, you don't really know what you want, the target dates are a really great way to start and then you can change that investment at any point, especially if you get some advice, do some homework. So you're not stuck in that investment essentially, but it's a great way to just start and get going.

Joe

Yep. You're better off just putting in a target date fund than you are putting it in a money market or stable value, you know, as a younger investor. So just invest — I guess the “save and invest” is a great strategy that most people, you know, over time, historically the stock market's going to produce some pretty good returns that are going to help you save for retirement.

Caitlin

So as we end, there's one last question. Is there a simple investment strategy that folks should be considering? I mean, you've mentioned a lot, the younger you are, the more aggressive because you have more time. But is that a set-in-stone strategy? Is there something folks should be looking for when they're considering their investment options?

Joe

You know, as simple as you can get is the target date funds. I think as far as 401(k) investing goes anyways, that's probably going to be your simple strategy. That way you don't, like we've mentioned multiple times, you don't have to build that portfolio. You are getting a fully diversified portfolio that's going to get professionally managed and rebalanced automatic. Everything's going to be basically automatic for you as long as you kind of take a look at and you know what the underlying investments within that target date fund are appropriate for you. So I would say at least that's the simplest, but I still think most people should at least take a little bit of time and learn what is actually involved. How do they work, what's actually inside of those investments.

Caitlin

Yeah, great. Well, it's been really nice talking to you, getting all this out on the table, so thank you so much for your expertise in our retirement investments.

Joe

Sure. Thanks for having me.