Understanding Retirement Plan Investment Options
The investment options available through a retirement plan can have a significant impact on how participants use the plan. But evaluating an investment lineup involves more than asking which funds are available.
Plan sponsors should understand what their current platform makes available, what restrictions or limitations apply, how much flexibility the platform provides, and whether other providers could offer a broader or more appropriate range of choices.
The goal isn't to offer as many investments as possible. Too many choices can overwhelm participants, while too few can limit diversification or prevent participants from accessing investments that may be appropriate for their circumstances. The right question is whether the platform and investment lineup provide the flexibility, diversification, cost, and support participants need.
How to Invest In a Retirement Plan
Investing through an employer sponsored retirement plan begins with deciding how much you can comfortably save on a consistent basis. Employees should establish a contribution amount that fits their budget and is sustainable over the long term. Whenever possible, contributing enough to receive the full employer match should be a priority, as it provides an immediate return on their investment.
Once enrolled in the plan, employees can choose whether to direct their contributions to a traditional 401(k), a Roth 401(k), or a combination of both, depending on their financial circumstances and long term objectives.
The next step is selecting investment options that are appropriate for each employee's age, financial goals, investment horizon, and tolerance for risk. While no single investment strategy is appropriate for everyone, a well constructed portfolio should seek to balance risk, cost, and diversification.
When evaluating investment options, employees should consider factors such as expense ratios, historical performance, and the extent to which different investments are correlated. Correlation describes the tendency of investments to move together over time. Simply owning several different funds does not necessarily create diversification if those investments generally rise and fall together. A well diversified portfolio typically includes investments that respond differently to changing economic conditions.
Employees should also view their retirement plan as one component of their overall investment portfolio. Investment decisions should be coordinated with assets held in other accounts, such as IRAs (Individual Retirement Accounts) and brokerage accounts. Looking at all investments together can help avoid unnecessary concentration in a single asset class and improve overall diversification.
Retirement planning is not a one-time decision. As an employee's financial situation, goals, and investment horizon change, their portfolio should be reviewed periodically to ensure it continues to reflect their objectives. An experienced retirement plan advisor can help employees make informed decisions and avoid common investment mistakes.
Building an effective retirement plan portfolio is often less complicated than many people expect. However, the closer an employee is to retirement, the more important it becomes to develop an investment strategy that reflects their unique circumstances and long term financial goals.
Optimal Retirement Plan Investment Options
There are many different types of retirement plan investment options available that can help employees create a diversified investment portfolio. However, it is easy to become muddled in all of the options, which can lead to your employees not choosing suitable retirement plan investments or not choosing any at all.
The broadest option is to offer a self-directed brokerage account, which allows the full range of investments that a custodian offers. There are thousands of investment options in these accounts, so the number of choices can be overwhelming, which is why it can be helpful to have an experienced financial advisor. The costs of these accounts can range from $50 to $400 per personally annually, or there can be an employer cost in some cases. And there can be limitations on how much participants can save in these accounts which can range from 50 to 75%, but in other cases there are no limits.
The main advantage of using this account is the ability to access alternative investments that aren’t available as part of the core investment offering. Gold and silver are two examples of non-correlated assets that can add meaningful diversification. A simple way to invest in these commodities is through ETFs (exchange-traded funds) that simply track the price of gold and silver. Some record keepers allow for ETFs in their core investment line-up, but most do not. Brokerage accounts also allow for investing in individual stocks, which can be particularly valuable for participants that have a skilled advisor. While investing in a broad array of U.S. stocks has generally been a good strategy, investors are going to need to implement for sophisticated diversification strategies in order to maximize their returns.
More specifically, in an era of unprecedented market distortion where years of artificially low interest rates have overvalued financial assets and undervalued real assets like commodities, self-directed brokerage accounts provide the essential tool for sophisticated diversification beyond traditional stock and bond allocations. While the U.S. stock market trades at historically extreme valuations due to monetary policy distortions, commodities like gold, silver, oil, copper, and uranium offer compelling value propositions that are simply unavailable through typical retirement plan core offerings. The ability to access these alternative investments, combined with tactical individual stock selection guided by experienced advisors, transforms retirement accounts from passive wealth preservation vehicles into active wealth optimization platforms. As markets inevitably revert from their current distortions, participants with access to undervalued real assets and strategic diversification will be positioned to capture the rotation of capital from overvalued financial assets to historically cheap commodities and alternative investments.
However, most employees will find a select few to be the most suitable for their financial situation. Here are a few typical retirement plan investments that employers consider offering their participants as part of the core investment line-up.
Target Date Funds
A common investment option is a target date fund, which provides an investment allocation based on the year an employee believes they will retire. Keep in mind that this investment option will be impacted by how many investing years they have, as a longer timeline allows them to withstand market fluctuations better.
Before you move ahead with a target date fund, you also need to consider the fact that there are several different types. Different target date funds can have different risk levels and costs, and some companies may provide plans with more aggressive allocation than others. Different plans may also become more conservative after they pass their retirement date, while others may maintain the same allocations after the retirement date.
S&P 500 Indexing
Another common option for employees is to invest in the S&P 500 through 401k index funds. The S&P 500 index fund tracks the largest companies in the United States based on market capitalization. When you use this option, your employees can easily follow the market activity of these top companies.
Choosing an S&P 500 indexing fund allows employees to create a portfolio of U.S. stocks and bonds for their retirement plan. It can provide versatility without being overly complex. It also has a good track record of consistency.
However, at Paul D. Sippil & Associates, we recommend that individuals do not rely on an S&P 500 index fund entirely, as it isn’t as reliable as it used to be. For full diversification, it is best not to rely entirely on U.S. stocks, especially since the U.S. faces risks, such as economic uncertainty, inflation, and the erosion of the U.S. dollar.
Customized Risk-Based Investment Models
Customized investment models constructed by an experienced financial advisor can provide a properly diversified portfolio that covers various asset classes, including alternative assets like gold that aren’t correlated to U.S. stocks or bonds.
Unlike most target date funds that are solely based on age, these models take other factors into account such as income, debt, and net worth. However, while target date funds are automatically adjusted as participants get older, the investment models have a static allocation, so employees need to periodically monitor their risk tolerance and determine if they should invest in model with a different risk level.
Evaluating Investment Options and Participant Support
There are advantages and disadvantages to different types of retirement plan investment options, and the right approach depends on the needs of the workforce and the resources available to support participants.
Target date funds can provide a simple way for employees to invest based on their expected retirement date, particularly when a plan does not have an advisor with enough time to meet individually with participants. In other plans, customized investment models may provide greater flexibility when an advisor has the time and expertise to meet with employees and help them develop an allocation appropriate for their circumstances.
The question for a plan sponsor is not simply which investment option is best. It is whether the plan provides an appropriate combination of investment choices, flexibility, education, and individual support for its participants.
Personal meetings can help employees understand their choices and make more informed decisions. Retirement plan record keepers also provide tools such as retirement calculators, but having access to a tool does not necessarily mean employees will use it effectively. Education and individual guidance can help participants understand how those tools work and how they apply to their own circumstances.
Evaluate Your Plan’s Investment Platform
Most employees do not fully understand the investment options available through their retirement plan, and employers may not fully understand the choices and limitations built into their current investment platform. A knowledgeable advisor can help employees make more informed investment decisions, but employers should also evaluate whether the advisor is delivering meaningful value through education, guidance, and ongoing support.
At Paul D. Sippil & Associates, we help employers make better retirement plan decisions by selecting service providers through a disciplined purchasing process and by improving employee engagement through ongoing retirement education. Contact us today to learn how better service provider selection and better employee education can lead to better retirement plan outcomes.
