How to Choose Markets to Invest in For a 401K

29
April

Although it may appear bewildering to decide on the best investments for a retirement plan, when selecting markets to invest in for a 401K, an investor may want to think about the many benefits of the Exchange Traded Funds (ETFs).

What Are ETFs?

ETFs were created by “Spider,” the nickname for SPDR, the Standard & Poor Deposit Receipt way back in 1993. They quickly became popular because investors could follow the S&P 500 without the cumbersome necessity of purchasing an index fund.

How ETFs Work

Exchange Traded Funds (ETFs) are specifically designed to help those looking for advanced investment strategies. Although an ETF is a fund that follows an index, it can be traded just like a stock. ETFs bundle the securities in an index. Investors like ETFs because they can treat it just the way they would a regular stock; for instance, they can short sell. Moreover, since ETFs are traded on stock exchanges, they can be easily bought or sold at any time during the trading day, which makes them much more flexible than mutual funds. And, just like a stock, the price will fluctuate. The downside is that an investor will have to go through a broker to make a purchase, which also means that there will be a commission involved for the transaction. The upside is that ETFs are much more tax friendly than regular mutual funds. What’s more, since they pursue indexes, the operating and transactional costs are unusually low. And to sweeten the deal, there are neither sales loads necessary nor investment minimums that are required to buy an ETF.

ETFs And 401Ks

As any investor knows, a solid strategy has to be customized to reduce personal risk by improving how funds should be allocated. Professional wealth managers use investments that allow retirement plans like IRAs and 401Ks to flourish. Those creating a retirement plan like the many features of ETFs. Although popular with investors because of their low expense ratios, liquidity, and lack of limitations, they are not well known in the field of retirement planning. This makes them something of a novelty for financial planners. However, once financial planners have discovered the many benefits of ETFs, they consider them an excellent way to beef up a retirement account.

Three ETF Strategies

When developing a strategy with ETFs, an investor can create a balanced portfolio, a buy and hold portfolio, or a portfolio that dynamically adjusts to market conditions. Naturally, the risks and returns depend on the level of aggression; consequently, a balanced portfolio will average around 3 percent, a buy and hold about 5%, and a dynamic portfolio that tracks the market about 10%.

Here are some examples of what these three strategies might look like.

1. A balanced portfolio:
• US Equity 52%
• International Equity 3%
• Bonds 45%

2. The Strategic Asset Allocation (SAA), a buy and hold portfolio:
• US Equity 15.00%
• International 15.00%
• Emerging Market 15.00%
• Real Estate 15.00%
• Bonds 40.00%

3. The Tactical Asset Allocation (TAA), a dynamic, shifting portfolio that changes with market conditions:
• US Equity 0%
• International Equity 0%
• Emerging Market 0%
• Real Estate 29.00%
• Bonds 71.00%

How to Design an ETF Portfolio for a 401K

Since 401Ks are long term instruments, the 5 year time frame offers plenty of room to evaluate the performance of a portfolio.

Here, then, are some points to keep in mind when thinking about ETFs in a 401K plan.

1. ETFs are low cost and effective and fit a 401K plan very well.

2. Once you become familiar with investing with ETFs, you should push the role of ETFs in your retirement plan.

3. Using five asset classes delivers superior performance.

4. A dynamic portfolio (TAA) will offer a high return if the market is volatile.

5. Think in terms of long term returns rather than short term gains when choosing the best ETF investment strategy for a 401K plan.

This post was written by

jason – who has written posts on Budget Clowns.
Father of three and married to a lovely women. Always looking for ways to save money, and invest it properly for my children's future.

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