A millennials guide to 401(k) investing

In my last column, I discussed the employer-sponsored retirement plan known as the 401(k) and the importance of availing yourself of one. This week you might be thinking, “well now that I have a 401(k), what do I invest it in and how much should I save?”

Here are the basics:

How much to sock away?

A precise answer depends on how much you need for retirement, how far off your retirement is and what kind of lifestyle you want. Evaluate what contribution will fit your budget; however, you should try to contribute at least enough to get the full employer match. And remember, there is a limit to how much you can contribute annually. For 2015, it’s $18,000 or $24,000 if you’re 50 or older.

To Roth or not to Roth?

Your company may allow you to choose a traditional 401(k), a Roth 401(k) or both. With a Roth, you pay taxes on your contributions on the front end, but you pay none on your withdrawals. (With either option, you must be 59½ to begin using the money or contend with stiff penalties.)

If you’re young or aren’t in a high tax bracket, a Roth could be the way to go because you’ll have plenty of time to make up for the up-front taxes and/or your tax rate isn’t enormous to begin with. If your returns are good, you could build quite a balance over the decades — paying no taxes on it would be some serious icing on that cake!

Set it and forget it?

Your options will likely be mutual funds — an investment vehicle made up of a pool of funds from people like you for the purpose of investing in stocks, bonds and other assets — and will almost certainly include a type known as the target-date fund. As the name implies, these funds have a target date, such as 2040 or 2055, for your likely retirement. The managers of these funds make asset allocation decisions based on that date, generally starting out more heavily weighted in riskier equities and gradually growing more conservative — with bonds, for instance — as the target date approaches.

Target-date funds make investing simple for those who won’t be hands-on. For investors who aren’t impressed with a one-size-fits-all approach — because each of us has different risk tolerances, objectives and investible income, after all — and are willing to rebalance their portfolios themselves, target-date funds may not be the answer.

Index fund or fund manager?

You may see other kinds of mutual funds with words like “index,” “growth,” “value,” “blend,” “large-cap,” “mid-cap” and “small-cap” in their names or descriptions. An index fund is constructed to mimic a market benchmark index such as the S&P 500, Russell 2000 or the Barclays Capital Aggregate Bond Index.

“Indexing” is considered a passive form of fund management because it simply invests in the securities that make up the index. Consequently, index fund fees are very low. Other mutual funds are actively managed because the fund managers are trying to achieve a stated investment objective. Their research, monitoring, analysis and strategy isn’t free. You’ll typically see a larger fee coming out of your account for these funds.

In two weeks, my column will address the variety of mutual funds and the passive versus active debate.

What to look for in any fund?

These are the essentials:

• Performance: It doesn’t hurt to look at previous years’ returns; however, remember that past performance does not indicate future performance.
• Low fees: A fund’s fees — what you are charged annually — shouldn’t be more than the average of its peer group. These expenses can eat up your gains.
• Solid management: If you’re opting for an actively managed fund (as opposed to an index fund), see if the manager has a record of success.
• Diversification: Make sure your portfolio isn’t over invested in one sector such as technology or industrials or one style such as growth or value. If one fund doesn’t offer the diversification you want, you can usually divide your 401(k) into multiple funds.

In retirement planning, decisions both good and bad have a way of becoming amplified over time if you don’t frequently review and tweak them. For extra guidance, consider talking to a financial adviser.

Jennifer Pagliara is a financial adviser with CapWealth Advisors, LLC, and a proud member of the millennial generation. Her column, which appears every other Saturday in The Tennessean, speaks to her peers and anyone else that wants to get ahead financially.