Retirement Plan Investing
Fund Selection

In order to help preserve financial security in your retirement and successfully manage the funds available in your 401(k) account, an asset allocation mix must be implemented and the most appropriate individual funds offered in your 401(k) plan must be selected. After an optimum asset allocation mix is designed for a portfolio — based on risk tolerance and return expectation — the actual investments used to incorporate the allocation must be selected. Our focus here will be on mutual fund selection, as the options in most plans continue to weigh heavily towards mutual funds.

There are thousands of mutual funds to choose from, so to help make the process more manageable, a simple screening process can reduce the number of funds in consideration. There are numerous free screening tools online and they all can be helpful. The important question, of course, is what criteria to screen.

On any marketing communications piece for a mutual fund, you will likely see a disclosure that reads: "Past performance is no guarantee of future results." Although this seems obvious, it should be taken as an explicit warning against exclusively looking at historical returns when selecting a fund, or even having historical returns as a top consideration. Good performing funds can become laggards due to a number of reasons. The good performance can attract increasing amounts of fund flows, which force the manager to buy more securities, diluting their best ideas. Larger funds also become less nimble and lose their ability to adjust to market conditions. Also, simple luck can have a role in performance, as some out performers exist simply due to chance. If not performance, then what else?

On average, the less expenses that a fund charges, the more that an investor gets to keep, and the greater the returns. With so many fund choices out there, don’t settle for a fund that is charging more than its peers.

Management Tenure
Look for funds where the current manager has been around a long time, at least through the latest full market cycle. A fund with a great track record doesn’t do you any good if the manager that achieved that track record is no longer in command.

Low Volatility
Measured by standard deviation, the lower the volatility that a fund has shown in the past could be a good indication of what to expect going forward. Less volatility results in smaller drawdowns. Also, for psychological reasons, many investors prefer a fund that will deliver consistent returns and are less likely to sell when performance is about to rebound.

Downside Protection
Check the return history through the last market downturn. Funds that exhibit a low drawdown will typically do so again in the future. Not having to recoup investment losses makes it easier to achieve your retirement goals. Please see Downside Protection to learn more about the value of protecting the assets you have.

Historical Returns
Returns do matter; just don’t overemphasize the track record of a fund. Also, pay attention to the consistency of returns. Look for a fund that is consistently beating its peers instead of one that is currently showing outperformance in the latest trailing returns. If a fund has shown periods of above average performance along with below average, you may be selecting that fund as it moves into a period of underperformance.

Finally, think of selecting a mutual fund not as a product or return stream, but more as hiring a manager to personally manage your money. Think about how you would manage a fund in a particular asset class, and select a manager that adheres to those principles.

Although an appropriate asset allocation mix is essential to ensuring financial security in retirement, the selection of the actual funds to implement your allocation is also important. This is especially true in 401(k) accounts, as your options are most likely limited, making fund management in your 401(k) even more difficult.