The Background

For millions of Americans, 401(k) investments represent one of their main sources of retirement savings.

Yet taking advantage of the tax advantages of 401(k) plans can involve navigating around some obstacles.  Common 401(k) flaws include:

  • Limited investment choices
  • Bias toward company stock, an inherently dangerous way to invest
  • High expense ratios
  • Limited or no tools to help employees build and maintain a smart, disciplined asset
  • allocation plan

Moreover, many investors with 401(k) plans make fundamental mistakes in choosing and managing investments:

  • They fail to take full advantage of the annual tax-deferment advantages of a 401(k)—especially if there is a company match program
  • They concentrate their investments in company stock, negecting the importance of diversification – think Enron
  • They invest too conservatively.  Many investors in their 40s and even 50s won’t be taking distributions from their 401(k) (or Rollover IRA) investments for 20+ years.   Over-allocating to cash or fixed income in mid-life will substantially limit portfolio growth over a long time frame
  • They don’t adjust their investments as portfolio risk often rises over time

Prudent 401(k) Investing—Do’s

1)    Make 401(k) investing a priority.  Take full advantage of any company-sponsored investment matches.

2)    Build (with help from an investment advisor, if desired) a sound, long-term asset allocation.  Ideally, create a whole portfolio asset allocation, including investments in your IRAs and taxable brokerage accounts.

3)    Make sure you understand your time horizon for your 401(k) investments.   Penalty-free distributions can be taken at age 59 ½.   But many investors choose to wait until the mandatory distribution age limit of 70 ½.  So the time horizon for your 401(k) investments may be longer than your initial instincts suggest, and so your asset allocation should be more weighted toward equities, as opposed to bonds.

4)    As you approach the age when you will draw down on your 401(k) investments; change your asset allocation to lower your equity allocation.

5)    Use mutual funds for diversification,  and, when possible, use index funds.  Be very aware of the operating expenses for the mutual funds.  Many actively managed MFs (and even some index funds) have expense ratios of over 1%– which will eat into your investment returns over time.

6)    Even better, if your plans allows you to set up a “self-designated brokerage account”;  take advantage of that option….which allows you to invest in low-cost index funds that are available from the retirement plan custodial firm (usually a brokerage firm or mutual fund company).

7)    Move your old 401(k) plan investments to a discount brokerage firm through a roll-over IRA.  That will give you access to a much larger world of investment choices—especially, low-cost index funds.

8)    Consider using an advisor (especially if you can work with a low-cost, registered investment advisor) to create and maintain an appropriate long-term asset allocation.

And Don’ts

1)    Avoid investing in company stock.   While it can feel good to support the company you work for, investing in a a single stock dramatically increases the risk in your 401(k) retirement nest egg.

2)    Don’t be overly conservative.  Some investors believe that because 401(k) investments are for their retirement, they should take a very cautious approach and invest only in fixed income (or hold a high percentage of the portfolio in cash).   Remember that your time horizon is a critical determinant for your portfolio asset allocation.  If these are investments which you will harvest in 20-30 years; you should have a healthy allocation to equity mutual funds.

3)    Don’t forget to review your portfolio asset allocation.   If you have made a decision to have a 70% equities / 30% fixed income asset allocation; make sure you review (and adjust) your portfolio annually to stay on target.

How 3 Factor Indexing can help clients with 401(k) investments

At 3 Factor Indexing, we often work with our clients to incorporate their 401(k) investments into a whole portfolio asset allocation.  In doing so, we help our clients build a smart risk-adjusted portfolio plan which takes into account taxable accounts, IRAs, Roth IRAs, and 401(k) investments.

For clients who have 401(k) plans at Schwab, we can also assist in setting up and managing a self-designated brokerage account, which allows 3 Factor to implement state-of-the-art techniques and highly regarded fund families such as DFA (Dimensional Fund Advisors) or Vanguard funds, regardless of the constraints of the 401(k) plan.

We also can assist clients in the process of rolling over old 401(k) plans.  We find that many of our clients over their careers have contributed to multiple 401(k) plans.  But after leaving previous employers, some of these investments are languishing without attention. Simplifying and consolidating retirement accounts is usually a great step in improving performance and reducing investment expenses.

And through our proprietary software, we can constantly monitor our clients’ portfolios, rebalancing when appropriate, to maintain an appropriate asset allocation and to focus on the most tax-effective portfolio re-balancing trades.


Past  performance is not a predictor of future performance.

*3 Factor Indexing LLC has conducted extensive analysis concerning portfolio performance. Please refer to our website at  http:3factorindexing.com/important-disclosure/ for details and disclaimers regarding a statements concerning performance, and the various assumptions we have made in our analysis.

The views and information contained within this article are provided for informational purposes only and are not meant as investment advice. They represent the author’s current good-faith views at publication time and are subject to change without notice. As with any strategy, it is important for an investor to fully understand the strategy prior to investing; seeking advice from a professional advisor can be a good place to start.

The information that is provided herein has been compiled to the best of our ability. However, the authors makes no warranty of any kind, expressed or implied, and will not be held responsible, or liable for errors, or omissions resulting in any loss or damage caused or alleged to be caused, directly, or indirectly, by information contained in3 Factor Indexing’s publications.

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