the way to find the best 401(k) fund to put your retirement money into
click here for the original article on www.acc.org
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click here for the original article on www.acc.org ♥️♥️♥️
In Part 1, we talked about how tax-advantaged retirement accounts like the 401(k) creates advantages for you with the employer match and compound interest. Using plans like these help you save for retirement without thinking about it. This is a huge advantage since most of us are terrible at saving for a rainy day.
Automatically siphoning your money into designated accounts makes saving painless.
We’ve talked about compound interest before. Just like in medicine, it’s one thing to understand the theory and something different to understand a real-life example. So let’s talk about a real-life example.
I’m not a financial advisor but my co-fellows wanted me to take a look at their 401(k) options after I kept badgering them about this tax-advantaged retirement account. So I took a look and made some changes.
I set up my co-fellows to make $1,481,711.08 more than the default option*.
In my estimations, their default plan would give them $818,871.65; the new plan would give them $2,300,582.72 instead. The difference is $1,481,711.08 – just by choosing the right portfolio.
How?
I found plans that had higher expected rates of return and lower costs. Unfortunately, you have to dig through the numerical weeds to find the hidden gems.
Here are the three guidelines I used to find good plans:
Rule #1 – Find A Low Turnover Rate
The turnover rate is exactly what it sounds like. Essentially it’s an estimate of the number of trades that occur over the course of the year in a given fund. Managers get to make as many or as few trades as they see fit, moving companies in and out of funds, trying to increase the returns on your retirement money. This seems like a good idea until you realize that most managers get paid every time they make a trade whether it benefits your or not. They get to put your money in their pocket each time they trade.
A high turnover rate means that managers are making more trades. More trades means more money coming out of your retirement. A low turnover means managers are making less trades and more money stays in your account.
A good fund manager should be able to give you better returns on your money, beating market returns consistently. Beating the market consistently is very difficult. Some managers may be able to do this for a year or two, but you’re most likely a few decades away from retirement. The odds of beating the market 20-30 years in a row? Minuscule.
The default fund my co-fellows chose had a turnover rate of 29%. The fund I picked for them had a turnover rate of 2%. The lower turnover rate will leave more money in my co-fellows retirement account.
Rule #2 – Ignore the 1-5 year Projected Performance, Retirement Is Still Far Away
If you look at the overwhelming amount of information 401(k) plans give you for different funds, there are usually a few projected performance numbers for 1 year, 5 years, and 10 years. Most of these numbers are here to confuse you because for most of us. Most of us have decades in the work environment and in the grand scheme of things the 1 year performance doesn’t matter.
These projections are not guarantees. They are based on past performance of the funds. The past doesn’t predict the future, but it’s the only information we have to use.
The default options that my friends picked showed a 10-year performance of 11.07%. Not bad.
If you look at the rest of the market the performance of the default option isn’t as good as the rest of the market (S&P 500), 11.07% vs 15.43%. Why lose that 4.36% difference if we don’t have to? Remember the power of compound interest!
Over the course of 30 years, this small difference inflates to a difference of hundreds of thousands of dollars ($223,969 to be precise).**
Rule #3 – Fear the Fees
Fees are insidious. They chip away at your investments and conveniently find their way into the pockets of fund managers.
While it’s very difficult to find the fees when it comes to the 401(k), the expense ratio gives us a good amount of information.
Small numbers are important. The expense ratios are very small like 0.65% or 0.015%. While it doesn’t seem like there’s much of a different in these two fractions, the difference is important.
Compound interest works both ways unfortunately. Fees compound just like gains. Over a thirty year time frame, small differences in fees like 0.65% ($46,153.52) and 0.015% ($2,361) annually amount to a difference of $43,792.29 in total.***
Don’t be fooled by small numbers, they add up quickly and eat away your retirement funds.
Putting it all together
In most 401(k) offerings, index funds are available. If you look at the numbers, these funds often beat the other funds that are offered when you look at a 10-year performance metrics. Low fees, better returns, and low turnover give your money more room to grow.
When picking funds, look for funds with:
a low turnover rate
high long-term projected returns
low expense ratio (small numbers matter)
The default option would have given my co-fellows $800k for retirement; $2.3 million is much better. These numbers will be more the more money you put into the accounts like when we’re attendings. The principles will remain the same.
Let me know what you think. Think my math is wrong? You can check it yourself. Comment below if you think I’m completely off base.
If you’d like to check my work you can click this link to download the excel spreadsheet I used.
I can’t guarantee any actual outcomes. Financial planners spend their entire lives and millions of dollars trying to predict the future. They are often wrong, so I’m sure I will be too.
This simulation just takes into account a few variables. Market forces over the course of 30 years will change these estimates.
All of this is just to say that this is only a tool.