How to Invest Your First 401(k)
Q: I just started my first job after college, and I want to sign up for my company’s 401(k). How should I invest it?
A: By saving in a 401(k) plan while you're still in your 20s, you give yourself a huge advantage—you’ll actually need to save less money for retirement than someone who gets a later start, thanks to the power of compounding.
But figuring out how to invest that money can be daunting. According to a survey by Charles Schwab, half of people find explanations of their 401(k) investments more confusing than their health care benefits. Another 46% say they don’t know what their best investment choices are, while 34% say they feel a lot of stress about how to allocate their 401(k) dollars. The sheer number of fund choices can also be overwhelming: the typical 401(k) plan offers 19 investment options, according to the Plan Sponsor Council of America.
The good news is that when you’re starting out, you can keep it simple, says Jane Young, a fee-only financial planner at It’s Not Just Money in Colorado Springs. If your company offers a target-date fund (nearly 70% do), that can be a smart choice. With a target-date fund, you get an instant all-in-one asset mix that gradually shifts to become more conservative as you approach retirement. A 25-year-old worker who plans to retire at 65 might choose a 2055 target-date fund. It would keep the bulk of its assets in stocks, which provide growth but are more risky than bonds or cash. When you’re young, you can afford to keep more in stocks, since you have decades to recover from bear markets. (If you want to minimize risk, you could opt for a more conservative target-date fund—you don't have to choose one with your retirement date.)
If your plan doesn't offer a target-date option, build a portfolio yourself using core funds, such as an S&P 500 stock index fund and an intermediate-term bond fund, says Young. Look for the lowest-fee funds, which will allow more of your money go to work for you. (For more on selecting good, low-cost options, see how we choose our Money 50 list of recommended funds.) A reasonable mix for someone in their twenties: 20% of assets in a bond fund and 80% in stocks. In the equity portion of your portfolio, invest 50% in large company stocks, 25% in international stocks, and 25% in small and mid-size companies.
Ultimately how much you save for retirement is more important than how you invest it. So be sure to put away enough to get your employer's full matching contribution. Keep increasing your savings rate until you are contributing 10% or more—some investing experts suggest that Millennials save at least 15% of income (including your company match) to ensure a secure retirement. And by diversifying and opting for low-cost funds, you will make the most of your 401(k) plan.