Adam sank onto the couch and sighed contentedly. His first day of work was on the books, and it was a good day at that. He glanced over at the packet of enrollment information that he needed to go through to elect his health coverage, 401K, and various other benefits. Remembering his grandmother’s advice on contributing to his 401K, he began to peruse the information on the company’s 401K. Deciding there is no time like the present, Adam pulled out his laptop and set out to enroll in the 401K program. As he made his way through the first steps, he let out a triumphant “Yes!”. The company contributes 100% of the first 5% of the employee’s contribution; Grandma would be pleased. He elected the 5% contribution, went on to the next step: Allocating the Account, and immediately felt overwhelmed. “Looks like it’s time to move up that second lesson,” he thought to himself as he reached for his phone and dialed his grandmother.
After a few rings, Margaret answered the phone with an exuberant “Adam! How’s my guy?”
“I’m good, Grandma. I had my first day of work, and so far, so good! I definitely think I’m going to like it there. But I’m at a loss with this 401K stuff you wanted me to set up.”
“Oh, why don’t you pop by and we can walk through it together?” Margaret replied, always happy to get some extra time with her grandson.
Adam agreed and headed over to his grandmother’s, laptop in hand.
After catching up for a few minutes, Adam fired up his computer and the two got down to business. “Gram, look at all these options! How’s a person supposed to know what to do?”
“I know it looks overwhelming, but we are going to simplify this a bit as you are just starting out. When your balance begins to grow, we can start to talk about diversification, but let’s not blow your mind with that just yet. At this point, we want to focus on two things: being aggressive and keeping costs low.”
Observing Adam’s dumbfounded expression, Margaret continued, “Ok, let’s start with being aggressive. Because you have so much time until you retire… Sorry, Charlie!” she exclaimed with a wink, “volatility is your friend. I know you’ve heard us all talk about the ups and downs of the stock market through the years. When you are close to retirement, these dramatic swings can be pretty scary, but with all this time ahead of you, you’re in a position to reap the benefits! For now, you’ll want to invest in a Total Stock Market fund. So, let me see… that narrows it down to just five choices!”
“Ok, great!“ Adam exclaimed, looking relieved and happy his grandmother could help. “So, what’s next?”
“Now we have to look at the expenses. Your grandpa was always talking about keeping investment fees low… well you know him, he wanted to keep all fees low,” Margaret laughed and went on, “but it usually served us well!” She scrolled through the investment options and paused when she came to a section that broke down the expense ratios and pointed to the screen. “Ah, this is what we need. Look at this.”
Adam leaned over as his grandmother pointed out the fees associated with each of the five options. “Why are the fees all so different?” he wondered.
Margaret explained, “These are the charges that are passed along by the owners of these funds. But here’s the thing. If the funds all perform roughly the same which we can see that they do base on these performance numbers, then you need to be singularly focused on the fund with the lowest fees so that we’re keeping expenses as low as possible.
“Think about it like this: if you go to the drugstore, you can buy store-brand Ibuprofen for $5 or the name brand for $10. When you look at the ingredients of what is inside the packaging, you realize that they are identical. So basically, you are paying a $5 surcharge for the name, right?”
Adam nodded and she continued, “When you pay that ‘extra surcharge’ with investments, it has a long-lasting impact on the growth of your account, so we want to find the fund with the lowest fees. Oh, look, this one will do nicely!” Adam clicked on the investment, hit submit, and turned to Margaret, giving her a big hug. “I guess I’m on my way! Thanks, Grandma!”
Retirement 101: Lesson Two: Investing in Your 401K When you are starting out, time is on your side, so take advantage of that and consider investing aggressively. When you are young and your time horizon until retirement is long, volatility (the ups and downs in the market) is your friend. Rather than seeing the “loss” in your 401K statement when the markets are down, consider the upside: that your ongoing contributions are purchasing new shares at a cheaper rate! And speaking of “cheap,” keeping your investment expenses low will be one of the key factors to your portfolio’s long-term success.