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Investment Options for 401(k)s

December 21, 2021

401(k) Investment Options

Saving for retirement is a great way to look out for your financial future. A typical 401(k) can have anywhere from a couple to several dozen options of investment. These options usually include funds of varying risk tolerance or company stock. We have compiled some of the most common and effective 401(k) investment options to help you understand what they are and how they can affect your 401(k).

ETFs

ETFs, or exchange-traded funds, are essentially a collection of stocks grouped together for one price. If you invest only in one stock, your return is solely based on the growth or decline of that one company. However, buying one share in an ETF is similar to buying percentage shares of a multitude of stocks. Each type of ETF has its own associated risks, which means research is imperative to understanding and implementing ETF options correctly. ETFs are unique compared to other funds because of its evaluation process. ETFs are traded like any singular stock. It is evaluated multiple times a minute and traded on that value at any time during market hours.

ETFs cast a wide net. As a result, it is safer than an investment in only one stock. However, the risk of an ETF is based on the type of stocks that the ETF invests in. The historical market performance of an ETF as well as industry statistics can assist in evaluating risks.

Mutual Funds

This is by no means an exhaustive list of all types of mutual funds, but it does provide a broad overview of many commonly offered funds as well as those with varying risks.

A mutual fund works in a similar way to an ETF. Both are a conglomerate of stocks that are bundled in different quantities to be traded at a single price determined by the health of those individual stocks. However, mutual funds are only evaluated once per market day and traded at that price for the entirety of that day. For example, if the fictional mutual fund (MFUND) is trading at $50, it will remain at $50 for the duration of the trading day until it is reevaluated. Once it is reevaluated on the following market day, its price has the potential to raise, decrease, or stay the same.

While many mutual fund stocks are chosen by their market cap or perceived value, others can take into account more non-conventional aspects like company values.

Equity Fund

An equity fund is an overarching category of mutual funds which use a variety of factors to determine investment. The main categories equity funds use are size and sector. The size of a company is determined by three general groups:

  • Large-cap funds: Companies valued at $10 billion or greater.
  • Mid-cap funds: This includes companies worth $2 billion to $10 billion.
  • Small-cap funds: Companies that are worth anywhere from $300 million to $2 billion.

On top of this, many equity funds take the sector into account. Some invest in one sector that they believe will outperform others in the long term. Others prefer to invest across sectors to diversify and prevent risk.

In general, the larger the company, the more structure the company has in place to avoid a large decrease in price, and therefore operate with less risk. However, the larger the company, the less likely it is to have large gains year-over-year.

In terms of sector, the more diverse the sector investment the less risky it is. However, it becomes less likely to take advantage of sector-specific gains.

Aggressive Growth Fund

Instead of investing in companies that have a stable but low returns, aggressive growth funds invest heavily into companies that are thought to have high growth and therefore high returns. Many of them can bring in above-average returns. However, this reward is offset by higher risk.

Aggressive growth funds usually invest in smaller companies and those not as established in the industry. Despite the possibility for high returns, it is highly likely that some companies will drag the fund’s price down. As a result, aggressive growth funds are highly volatile.

Bond Funds

Bond Funds take the same mindset of mutual funds and apply it to bonds. With a bond, you are essentially loaning money to the business or government in exchange for interest paid on that loan. A bond fund allows you to partake in a wide variety of bonds with varying interest rates without having to spend the full amount yourself. In both mutual funds and bond funds, you are sharing both the benefits and the cost of the respective investment.

Bonds in general are safer than the stock market because they rely on a contractual payment of interest, not company performance. Bonds are generally low in risk.

Stable Value Fund

Stable value funds are a type of bond fund focuses mostly on short-term bonds. The mentality is that short-term bonds are less susceptible to interest rate changes and therefore have a higher chance of producing a positive return. Stable value funds also have instituted a mechanic to reduce financial risk. Stable value funds invest in insurance contracts that provide protection against falling interest rates. They are essentially bond funds with extra protections. This results in a risk that is low. 

However, many stable value funds require investors to keep their money in the fund for a certain length of time. The length of time required by the fund may vary. If you choose to withdraw before the date laid out by the fund, it may result in penalties.

Target-Date Funds

Target-date funds or life-cycle funds are designed with retirement in mind. They are usually titled based on the year you want to retire. A 2060 fund, for example, is a target-date fund for those planning to retire around 2060.

 Target-date funds can be structured through investments in multiple mutual funds or directly in stocks and bonds. If the fund uses mutual funds as its primary investment vehicle it will compound the diversity of investment with each mutual fund, which further mitigates investment risk.

 Whether or not the fund invests in stocks and bonds or multiple mutual funds can depend not only on which fund you choose, but at which time you invest. A 2060 fund may choose to invest in stocks and bonds now as those who plan to retire in 2060 can more reliably handle the risk. As the fund and the person investing get closer to the retirement target date, the fund may switch to safer options such as mutual funds.

 This strategy is known as a glide path and can ease the transition from higher-risk investments to lower-risk options. However, each fund can have different glide path strategies. It is important to research both what investments the fund plans to make now and in the future before determining if it is right for you.

ROBS: Qualified Employer Securities

Let's imagine you have a brilliant business idea, but you do not have the funds to start it. While there would be enough money in your 401(k) plan to jumpstart your idea, 401(k)s do not allow withdrawals before the age of 59 ½ without significant penalties. The ROBS strategy is a way to use your 401(k) to invest in your business plan without incurring the fees and penalties of early withdrawal.

This strategy transforms retirement savings from an old retirement plan into company stock called Qualified Employer Securities (QES) in a new 401(k). This QES can then be used to fund business costs or capital ventures.

While the ROBS strategy can be effective, it can also be risky if executed improperly. Not only is starting a small business hard, but the investment is directly affecting the funds set away for retirement. Balancing retirement goals with achieving your business dreams is imperative to financial security and achievement. However, the ROBS strategy offers a multitude of opportunities for new small business owners or even established business owners to live out their dreams.

If you want to use retirement funds for your business venture, but are unsure about the risks, contact a licensed ROBS representative. They can help you decide if this strategy is right for you.

ROBS plans can be confusing, which is why we also provide a more in-depth explanation and answers to your frequently asked questions.

Company Stock

Company stock offerings for 401(k)s are currently on the decline. While many employees who have used their company’s stock option have received massive gains, others like those at GE have seen a massive downturn.

If you are investing in company stock through your 401(k), confidence in the stability and growth of the company you are invested in is key.

Company stock investment is one of the riskiest options to put a 401(k) especially if it comprises the entirety of your investment portfolio. However, combining company stock with other stock options and investment opportunities could allow for proper diversification and protection for your financial future.

Investment Options

ETFs, mutual funds, bond funds, QES, and company stock are great ways to invest through your 401(k). What you choose may depend on your age, risk tolerance, or future. Be sure to evaluate with your 401(k) provider exactly what options are afforded to you and if they are right for your investment values.

For more tips and information regarding retirement plans, contact us.

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