How to Become an Educated 401(k) Investor

— -- Investors in 401(k) plans face a tough challenge: They must choose the best investment products from their plans (choices are often limited to mutual funds) and manage these holdings as a portfolio.

This is extremely difficult for those who lack fundamental knowledge of investments. Indeed, many individuals who are highly financially literate, even chief financial officers, aren’t able to choose the best funds, in the right combination, for their particular situations.

Federal rules require companies to provide workers with extensive information about their 401(k) plans and the investments within them. But the overwhelming majority of workers have trouble understanding this information, much less using it to make suitable investment choices. This confusion often leads to participants choosing either a target date (age-based fund), which can be the most expensive type, or choosing a money market account that doesn’t earn net returns.

Too few employers provide actual financial education, and even fewer do so effectively. As a result, the majority of 401(k) plan participants don’t get the education they need to make good use of their plans. Here are some ways to bridge this education gap:

• Encourage your company to provide in-person or webinar education sessions. This isn’t as far-fetched as you may think. Though top company executives have retirement benefits that the rank and file doesn’t, these same executives are often participants in 401(k) plans. Thus, the brass share some interests with the rank and file.
• Absent the delivery of this kind of education from your company, seek out information from the websites of your plan provider, which is often a large mutual fund or insurance company. Plan participants might as well take advantage of what their plan providers have to offer, because they’re paying these providers fees out of their accounts.
• Consider hiring a financial planner on an hourly basis to help you select mutual funds from your plan’s offerings and structure them in the right amounts to meet your goals, within your capacity for risk. This can often be done with a couple of hours of consultation.
• Do your homework to find objective websites that provide investment knowledge — not those that try to sell visitors financial products. Examples include Brightscope and Financial Engines. These are far preferable alternatives to consulting fellow employees or friends who claim to have investment knowledge. These people are best avoided because they probably don’t know any more than you do regarding investing and asset allocation.
• In acquiring investing knowledge or guidance independently, seek familiarity with the concept of portfolio diversification — that is, including different types of investments in a portfolio to reduce risk from severe drops in value of any one type. Diversification is the basic idea behind asset allocation — deciding what investments to own and how much of each relative to other types.