2. Our List of Investment Choices
As we stated earlier, folks who do their investing in an IRA have unlimited investment choices. They can put their money into stocks, bonds, Treasuries, options, mutual funds, precious metals, currency - almost security can be bought and sold within an IRA. When it comes to 401(k) plans, the choices are usually very limited - although that does seem to be changing as many plans are beginning to add more mutual funds and even some ETF’s to their lists.
Let’s do a quick overview of the investment choices available to most folks’ 401(k) plans:
> mutual fund: a basket of stocks and cash managed with a particular investment goal in mind, such as…
growth fund: a basket of small to mid-sized companies believed to have great potential to grow and thereby increasing in price (best “bang for your investing buck,” but more volatile than other funds)
value fund: this basket has companies believed to be priced less than their true worth at the present time, but are expected
to “catch up” with their peers or the overall market soon and thereby increasing in price (not as volatile, but it
can sometimes take longer for the stocks in these funds to catch up)
blended fund: you guessed it - a little of both, companies poised to grow because they are just starting out or they are undervalued…and thereby increasing in price (a safe mix of the other two - popular with older investors who have a shorter time frame to work with)
international fund: also called “global funds,” these funds are made up of companies from outside the U.S. (they may do some business in/with the U.S. but they rely mainly on the growth of their particular country’s economy to increase in price
> bond fund: sometimes called “fixed income” investments, these funds are made up of bonds, T-Bills, corporate notes, etc. - basically safe, but low performing (though not always low performing!) places to park some moolah during bear markets
Most 401(k) plans have only one or two types of bond funds. The good ones will offer bond funds with different maturities
(long term, short term, etc.) and different issuers (municipal, corporate, banks, etc.).
> guaranteed interest/money market fund: the very least “bang for your investment buck,” but the safest by far (usually just like having money in a savings account down at the branch bank)
> company stock: some companies offer shares of their stock to employees at a discount, as part of their compensation or as their 401(k) match (not always an option, either)
> exchange traded funds: similar to mutual funds, some plans are beginning to offer ETF’s to their investors (kind of like a “high powered” fund, ETF’s are more industry specific than most mutual funds;
for example, XHB is a homebuilders ETF - the stocks it owns are all related to the home building industry)
> index fund: a basket of stocks that make up an index - duh! - an index fund owns shares of companies that make up a particular index,
in proportion to each company’s size (an S&P 500 index fund, for example, is made up of shares of each and every
company listed in the S&P 500 index, with the total shares of each equal to - or close to - the size of those
companies in the index)
Talk about choices! For the “lucky folks” whose 401(k) plans offer 3 or 4 different growth funds, a couple of value funds, a bond fund or two and 2 or 3 index funds and more, it’s easy to see why they feel intimidated when it’s time to set up their investment portfolios. Even plans that don’t offer as many investment choices can still make newbie-investors scratch their heads.
Fortunately, all 401(k) plans offer at least one S&P 500-type index fund. Index funds greatly relieve the pressure on new investors when they are trying to figure out where to invest their sweat-stained dollars. We mentioned it earlier: we like to use index funds because their expense ratios are low, they bring instant diversification to our portfolio and they are easy to track - heck, even the local TV news tells us what the S&P 500 did that day!
> Index investing, as this is sometimes called, has its detractors. Just Google the term and do some research. The main gripe you’ll find is: if you invest in an S&P 500 index fund, you’ll never “beat” the market. Well, that’s true. If you invest in a fund that mirrors an index, your results will be what that market’s results are. If the S&P 500 is up 5% in a year, your investment in that index will be up 5% (or very close, after fees).
Now, if you’re thinking, “I’ll just jump into some other funds or stocks in my 401(k) and make more than an old slow moving index fund,” consider this: 70-80% of professional money managers fail to beat the S&P 500 in a given year. The 20% that do can’t repeat their performance year in and year out. Also, the fees that come with these “actively managed funds” are sometimes 4 to 5 times higher than index funds and must be subtracted from the total return each year. [FACT CHECK!]
So if you think you can do better than the pros, have at it. But we’ll tell you from experience - if you work for a living, you don’t have the time or the resources to beat the market. And if you can’t beat ‘em, join ‘em, right? That’s why we use index funds as our investment "vehicles."