Every retirement plan is different. If you’ve been a participant in more than one retirement plan, you may have had the experience of enrolling in your new plan and not recognizing a single investment that you were familiar with in your previous plan. This can be a frustrating or even an overwhelming experience to feel like you’re starting over learning a new investment lineup. While the names may have changed, you aren’t starting from scratch. Plan administrators are required to follow a set of rules under the Employee Retirement Income Security Act of 1974 (ERISA) when selecting plan investments. This means that there is a common structure to what investment options can and must be offered in retirement plans. In practice, most plans today will offer a suite of mutual funds including target-date funds at a minimum. Many plans today may also offer managed accounts and self-directed brokerage services. We’ll examine each one in turn.
Mutual Funds
The most universal retirement plan investment options are mutual funds. These funds can be broadly categorized as target-date funds (TDF), asset allocation funds (AAF), and stock and bond funds. Any of these funds may be either actively or passively managed. Some plans offer all these options while others may only offer one.
Target-Date Funds
You probably have some experience with target-date funds. They are designed as a one-fund solution and are commonly used as the default investment when participants are automatically enrolled in a retirement plan. These funds target a particular date (e.g., 2030, 2035) with the expectation that the investors who own the fund plan to retire at the age of 65 around that year. The target-date fund invests in various stock and bond mutual funds to achieve an age-appropriate asset allocation which then adjusts, shifting from stocks to bonds over time with the goal of reducing portfolio risk. This is a simple solution for investors who prefer to delegate the task of adjusting their portfolio allocation over time. However, there are a few drawbacks to target-date funds. For one, not everyone plans to retire at 65. Additionally, there is a lack of transparency inherent in target-date funds since the investor is twice removed from direct ownership of the underlying investments (investor > TDF > mutual funds > underlying stocks and bonds). For investors who like to monitor their investments closely, want control over their asset allocation at any given time, or whose retirement plans don’t align with the target-date assumptions, a target-date fund may not be the right fit.
Asset Allocation Funds
Asset allocation funds provide a solution to at least one of those issues, control over asset allocation. These funds may appear in your plan with names like Aggressive, Moderate, or Conservative Allocation Fund. Rather than targeting a date and changing the asset allocation over time, asset allocation funds target a specific mix of stocks and bonds (e.g., 60% stocks and 40% bonds) and maintain that allocation as a constant. Asset allocation funds can be a potential solution for an investor who wants control over the stock and bond mix of their portfolio, but who prefers to delegate the management of precise stock and bond allocations. For those who want more control over their stock and bond allocations, there are stock and bond funds.
Stock and Bond Funds
The exact lineup of stock and bond funds will vary widely across plans. These are solutions aimed at plan participants who want to pick what types of stocks and bonds they own and who are comfortable managing the mix of stocks and bonds in their account manually.
This is the point at which the names of funds may become unfamiliar. However, there’s a structure to mutual fund names which may help you decode them. The fund name will always start with the management company (e.g., Vanguard, iShares, T. Rowe Price) followed by the fund name (e.g., S&P 500, Large-Cap Growth, Core Bond). Sometimes these will help you determine the investment strategy. That first example is easy to understand as an S&P 500 fund, the second you will understand if you are familiar with stock market capitalization, while the third may be a complete mystery if you don’t have an investing background. At the end of the fund name, you may also see letters or numbers (e.g., I Cl, R6, Tr). These are the share class of the fund. While share class determines the cost of the fund (more on this later), as a plan participant you don’t have control over the share classes available in your plan.
For an investor who isn’t comfortable with this level of account management or the jargon encountered with these funds, an asset allocation or target-date fund may be a more appropriate solution. However, if you want to understand these options better there are several key data points to understand when researching these, or any, plan investments.
Mutual Fund Data
Regardless of which option you choose, there are a few key data points you should understand about mutual funds: expense ratios, active vs. passive management, and historical return data.
The expense ratio of a mutual fund is the management fee of the fund, and it is always represented as a percentage (e.g., 0.10%) so it’s easy to compare one fund to another. This is an annual fee, so investors holding the fund over a 12-month period will pay one-tenth of one percent of their average daily balance to the management company. Fee extraction happens daily inside the fund, and you won’t see a fee charged to your account. Management fees have a direct impact on returns, so lower management fees should be a consideration when researching your fund options. However, expense ratios don’t tell the whole story.
For instance, index funds will usually have low fees because they are passively managed, which means they track a market index like the S&P 500. Your investment in an index fund will follow the index whether it gains 20% or loses that much. Actively managed funds will have higher fees than index funds because there is a management team actively adjusting the investment portfolio. That investment team will try to have better-than-market returns (i.e., outperform the index) through their active management. Some investors are more comfortable with active management for this reason and are willing to pay higher fees. Just keep in mind that no manager can guarantee against loss. For more information about index funds, see my colleague Eric Udvari’s recent video, What is an Index Fund?.
All mutual funds are required to publish annualized returns for specific time periods (1-, 3-, 5-, and 10-years). If you don’t see a 10-year return, that means the fund was created less than ten years ago. This standard performance reporting makes it easy to compare the historical returns of your plan investment options. However, it’s important to remember that past performance does not guarantee future results. Historical returns only tell you what has happened, not what will happen. The future may be different, and the fund which had the highest return last year could have the lowest return next year, so be cautious when using historical returns as a deciding factor.
There is an abundance of information available about mutual funds, and this is far from an exhaustive list. If you understand this basic information about mutual funds, you have a good foundation to understand and compare the options offered in your retirement plan. You also have the peace of mind that your plan administrator has a fiduciary responsibility to plan participants and has already done due diligence on these investment options before offering them to you as a plan participant.
One last important strategy to understand for an investor building their own mutual fund portfolio is rebalancing. If you choose a target-date or asset allocation fund solution, you don’t need to worry about rebalancing because it is built into those funds. However, if you choose a basket of stock and bond funds, some of those funds will outperform the others and your asset allocation will “drift.” Rebalancing is the process of selling from your outperforming investments and buying into your underperforming investments to bring your account back to your intended allocation. Fortunately, in an employer-sponsored retirement plan this is often easy. It can usually be automated on a 3-month, 6-month, or annual basis. You may also be able to manually rebalance with a few clicks or taps. Investors who choose to build their own portfolio should learn about rebalancing and determine what’s right for them.
If you’ve come this far and have yet to find a solution that’s right for you, there may be a few other options.
Managed Accounts / Advisory Services
Your plan may offer advisory or managed account services which may have an associated fee. This service may be provided either by an automated service (aka robo-advisor) or an investment advisory firm selected by your plan administrator. These services gather information about your risk tolerance and time horizon and then allocate to the available mutual funds in your plan based on your investor profile. There is usually a rebalancing component to these solutions as well. It’s a more personalized solution than a target-date fund and a more dynamic solution than an asset allocation fund. For an investor who doesn’t fit the mold of the target-date fund and prefers to delegate asset allocation adjustments, these can be a solution. If your plan offers managed account services, look for information regarding fees before making your decision. You will still pay the expense ratios of the mutual funds when using this solution.
Self-Directed Brokerage
Self-directed brokerage accounts in retirement plans are becoming increasingly common. This is a solution for the do-it-yourself investor who isn’t satisfied with limited plan-provided investment options. The self-directed brokerage is the wide-open range of investment options in retirement plans. Investors can typically access any publicly available investment they want including individual stocks and bonds, ETFs, mutual funds not offered in the plan, and much more. This is a solution for confident and experienced investors. If your plan offers a self-directed brokerage and you are considering it for your investments, be aware that investment research and trade execution are your responsibility. Your plan administrators have not done due diligence on investments which you can access here, and brokerage trading is different from making changes to mutual funds in your regular plan account. There may be an account maintenance fee to use a self-directed brokerage account in a retirement plan, trades on some investments may incur commissions, and still other investments may have complex fee structures. For investors who are comfortable with this level of responsibility and who want a broader range of investment options, self-directed brokerage can be a valuable solution.
Company Stock
One final common investment option in corporate retirement plans is company stock. If your company offers the option to buy company stock in your retirement plan, there are a few considerations. Company stock may have certain benefits like additional employer match or even tax incentives depending on the type of stock plan which can create unique financial planning opportunities. Additionally, owning the stock of your employer can give you a sense of ownership and allow you to participate in the fruits of your labor, so to speak. All of this can make company stock attractive, but there are caveats. Owning a large amount of any single stock can create concentration risk in a portfolio; this is the risk of financial loss tied to a single investment. In some ways, company stock exposure presents a greater risk than any other single stock exposure. This is because if a stock price collapses in an investor’s portfolio, they lose that value in their investment portfolio. If that company is also the investor’s employer, they may also lose their income stream at the same time. While exact guidelines for company stock allocation vary, they generally fall between 5-15% of a retirement plan portfolio.
Managing Your Retirement Investments Confidently
Now that you understand the common investment options in employer retirement plans, you have the tools to make informed decisions. Whether your plan offers target-date funds, asset allocation funds, stock and bond funds, or more personalized solutions like managed and self-directed brokerage accounts, you will be able to focus on the solution that fits your needs. If you are still unsure about your options or have more complex financial planning needs such as employer stock plans, Howe & Rusling is here to help. Even if we don’t directly manage your retirement plan, we believe it’s a vital part of your overall portfolio, and we’re committed to helping you integrate it into your broader financial plan.
Disclosures: This material is provided for informational and educational purposes only and should not be construed as investment, tax, or legal advice. The information contained herein reflects the opinions of the author and not necessarily of Howe & Rusling, Inc. as of the date of publication and is subject to change without notice. Nothing contained in this material should be interpreted as a recommendation to buy, sell, or hold any particular security, nor as an offer to provide investment advisory services. Investing involves risk, including the potential loss of principal. Different types of investments involve varying degrees of risk, and there can be no assurance that any particular investment strategy will be successful or suitable for any specific investor. Past performance is not indicative of, nor does it guarantee future results. Diversification and rebalancing strategies do not ensure a profit or guarantee against loss. References to target-date funds, asset allocation funds, mutual funds, managed accounts, self-directed brokerage accounts, or company stock are provided solely to illustrate general investment concepts commonly found in employer-sponsored retirement plans. They are not intended to imply that Howe & Rusling manages, endorses, or recommends any specific plan, product, or investment option. Participants should review all available plan materials and disclosures and consider consulting with their plan administrator or a qualified financial professional before making any investment decisions. Howe & Rusling, Inc. is an SEC-registered investment adviser located in Rochester, New York. Registration does not imply a certain level of skill or training.
