Investment choices for 403(b) and 401(k): How to predict future performance?

Question

My wife and I are in our 30s and live in the US. We have several retirement accounts, which include an old 401(k), her current 401(k), and my current 403(b).

These 3 all allow us to choose our investments, but until now we have just stuck with the default: 100% in 2050 target date funds. We are realizing now that these accounts have done poorly compared to the S&P 500 for years, and we need to get better returns.

The accounts let us choose from funds that include large cap stocks, small/mid cap stocks, international stocks, industry-specific stocks, short-term bonds, long-term bonds, and/or target date funds.

So I’ve been studying the Investment Performance charts and the individual profiles of each fund. I’ve been plugging in the rates of return and expense ratios into online calculators to try to get a general idea of future performance. (I realize that the market changes and portfolios rebalance, so I’m not treating these numbers as the truth - just trying to get enough of a general idea to feel able to pick from these funds confidently.)

At this point, I see two problems that keep me from making a decision:

First, I don’t know which numbers on the Investment Performance charts would be the most reliable. The charts include 3 month, YTD, 12 month, 3 year, 5 year, 10 year, and since-inception rates of return (sometimes other time ranges, too). And I realize this is all past performance that could change in the future. Are any of these past time ranges generally accepted as reliable when people need to make this kind of decision?

Second, I might have too many good choices - which could hurt or help our overall return long-term. Some of these funds are consistently beating the S&P 500 (and the 2050 target date funds) throughout most or all of these intervals. In large cap stocks especially, I feel like I’m trying to choose between several options that all look very compelling.

Answer 1

You're right to be asking these questions. Many company-sponsored retirement plans offer awful choices when it comes to funds. These poor performers often have hidden, high fees.

This answer has two parts:

1. Look at fund fees first. Every mutual fund has fees associated with it, fees that are taken out automatically from the returns. Look at the "Expense Ratio" and it should be as low as possible. Most of the recommended Index Funds have expense rations in the .05% and lower range. Many managed funds can be tens or hundreds of times more. These expenses add up over time and decimate your long-term growth. The worst of funds are "loaded", usually front-loaded, where the fund takes a commission right off the top, and any reinvested dividends also get hit. Run away from those like the plague.

2. Don't try to beat the market. Most money managers fail at beating the S&P 500 Index. Individual investors get fleeced because these funds charge high fees and still fail to beat the market. You should instead look for an Index Fund that matches the S&P 500, or any similar broad-market fund. If your retirement plans offer a low-fee Index fund as one of your options, jump on it.

As you get closer to retirement age, 5-10 years out, you can start to go a bit more conservative and reallocate to a mixture of bonds and equities, or even go back to a target fund (look for "target index funds" now with lower fees), but in your 30's, me, I would just go 100% Index Fund and sleep very well at night. (In fact, that's what I am doing. I'm older than you and just starting to re-balance as I get closer to retirement.)

Of course, you don't have to do all-or-nothing, you can mix it up in a bunch of different funds. But look at expense ratios and fees before anything else.

The reason behind my two-part answer is that you absolutely cannot predict the market in the short or medium term. If anyone could, they'd be wealthier than Bezos. In the long-term, however, the market will go up, and that's easy to predict. Therefore, I invest in the market, i.e. an Index Fund. Sure, Target Funds are better than nothing, but why pay fees to have a managed fund when you're young and can just take advantage of being entirely in equities for a couple decades?

Slow and steady will make you wealthy in your golden years.