HOW TO PICK FUNDS FOR YOUR 401K

How do you decide which funds to pick for your 401K or IRA account?

Are you confident or comfortable with your fund picks?

Most people do NOT have a disciplined or logical process for their fund selections. Ask ten ordinary investors how they make their picks, and you will get ten different answers. Ask ten investment professionals, and you will also get lots of different answers.

Some people:

• Follow the advice of their HR representatives or their 401K administrators.

• Are so afraid of losing money that they put their money in bonds and cash.

• Are overconfident in their investing abilities and move their money around based upon their own market forecasts.

• Follow the advice of financial professionals and spread their money across a variety of different assets – small cap stocks, large cap stocks, international stocks, mutual funds, bonds, and more.

The variety of approaches and the different investment strategies are a clear indicator of how dysfunctional the investment industry is. And none of the approaches listed above will generate enough growth for you to retire comfortably or securely.

With so much data and information available, the fund selection process should be disciplined and consistent. It should be pretty simple and straightforward. And it can be. The investment industry and the financial media make the process much more complicated than it should be.

Put very simply, you should be selecting your investments based on CONSISTENT AND RELIABLE LONG-TERM RESULTS. It should be all about the numbers – about which investments have the best odds of producing the best and most consistent returns in the long run.

It all comes down to what makes one investment better than another. There are only a few factors to consider when comparing investment options.

1. Expected long-term annual rate of return – the growth rate you can expect from an investment.

2. The consistency and the predictability of the expected returns.

3. The risk of losing money in an investment.

4. How well you understand the particular investment.

The most important statistic to measure any investment is its annual rate of return. For example, a bank savings account that pays 4% per year has an annual rate of return of 4%. For any investment, data is readily available regarding its annual rate of return over various time periods. Notice how I just introduced another factor into the equation – the time period to evaluate.

For investments, unfortunately, people too often look at very recent or short time periods to evaluate performance – for example, six months or the last year. Six-month performance or one-year performance does not tell you much about an investment. Most people will have their retirement accounts for 30 or 40 or 50 years. When you are comparing investment performance, therefore, you want to look at performance over at least 20 years and even 30 or 40 years.

The next factor is consistency. Let’s say two different investments (fund A and fund B) have similar annual returns over the last 20 years – both at around 8% per year. But the fund A achieved those 8% returns much more consistently than fund B. Consistent results are much more reliable when projecting future returns.

The next factor to consider is the risk of losing money. And the most important risk is long-term risk of suffering permanent losses. Most investments carry the risk of short-term losses because all financial markets are volatile. But individual stocks can and do suffer permanent losses when companies go out of business or lose sales to a competitor. Commodities can and do suffer long-term losses when they get replaced by other commodities. 401K and IRA investors should avoid any investments that could suffer long-term or permanent losses.

Let’s now cover the last factor to consider when picking your investments – how well you understand the individual investment. Understanding an investment is not just about knowing what it is, it is also about knowing why it increases or decreases in value.

I am totally convinced that S&P 500 index funds will grow by an average of 9% per year in the future because I believe that their profits will increase at a similar rate. The profits of the companies that make up the S&P 500 have grown by 8.7% per year over the last 50 years. And a 9% increase in profits for any company is not a big number. It is very realistic.

But I have no idea why the price of bitcoin goes up or down and nobody else does either.

When you don’t understand an investment, you do not have any conviction about holding on to that investment. Your buy and sell decisions end up being totally emotional.

Happy Investing,

Phil

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Disclaimers The Beyond Buy & Hold newsletter is published and provided for informational and entertainment purposes only. We are not advising, and will not advise you personally, concerning the nature, potential, value, or suitability of any particular security, portfolio of securities, transaction, investment strategy or other matter. Beyond Buy & Hold recommends you consult a licensed or registered professional before making any investment decision.

Investing in the financial products discussed in the Newsletter involves risk. Trading in such securities can result in immediate and substantial losses of the capital invested. Past performance is not necessarily indicative of future results. Actual results will vary widely given a variety of factors such as experience, skill, risk mitigation practices, and market dynamics.