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What is a 401(k) Account?
Most companies offer their employees the option to invest in a retirement plan to prepare for their future. These employer-sponsored retirement plans are known as 401(k) plans. Using a 401(k), employees are able to contribute some of their wages to a tax-advantaged retirement account to save for the future and help ensure a retirement with financial stability.
There is no one perfect 401(k) out there, and employers all over the country handle the accounts differently and offer their employees different options within the funds. Some offer a 401(k) match, some provide company stock as part of their 401(k), and others outsource the entire thing to big banks to handle it for them.
No matter how your company chooses to offer 401(k) to their employees, it’s important to understand how it works. After all, you never want to be investing in something that you truly don’t understand. One of the main questions that you’ll want to address is if your 401(k) is being actively managed or not so that you know what’s happening with your money.
What is An Actively Managed 401(k)?
When people invest in their employer-sponsored 401(k) plans, they typically do so with the assumption that the employer is actively working on the best ways to invest the funds. After all, who wants to invest for retirement with the assumption that they could be doing better with the investments elsewhere?
The good thing is that in general, both actively managed and passively managed funds perform well and at least mirror what the market is doing. But what is an actively managed 401(k)?
In an actively managed 401(k), there would be some sort of fund manager or fund management team deciding actively how to invest the funds in the 401(k). This means that you would add your 401(k) contributions to your 401(k) account, and the fund manager or fund management team would then invest it for you, in an attempt to beat the typical market index.
How is this Different From a Passively Managed 401(k)?
As just alluded to, the goal of an actively managed 401(k) is to beat the market index. Or in other words, active fund managers set out to do better than the overall market and therefore grow the funds for you at a faster rate. Passively managed funds, on the other hand, are designed to follow the market and mirror the overall index that they are based on.
So if you have a passively managed 401(k), you would likely just invest in a certain fund that is built to mirror its related fund in the actual stock market. The most common examples of this are funds built to mirror the S&P 500 market index. Most 401(k) accounts have an option that mirrors the S&P 500 index, providing great consistent returns over time.
In these funds, there are no investment decisions to be made by account managers. Just follow what the market index does so that the returns can be equal (or nearly equal) to what happens in the market.
How Do I Know if My 401(k) is Actively Managed?
Whenever you want to know any of the nitty-gritty details of your employer-sponsored plan, you can usually find all the info you need in the plan details themselves. When you’re opting into the 401(k) plan, the plan administrator should be able to quickly and easily tell you whether or not the fund is actively managed or not. As a fiduciary, they should know how your funds are being invested, and whether there are any fund managers actively making investment decisions on your own behalf.
Another easy way to determine if your 401(k) is actively managed is to take a look at the funds that you’re invested in and the other investment options that you have. Most of the time, actively managed 401(k) plans will use mutual funds as the main investment vessels. This is because the fund managers can decide which mutual funds they want to allocate the 401(k) funds to so that they can beat the typical market.
On the other hand, if your 401(k) options are index funds, then chances are high that it isn’t being actively managed. As mentioned previously, index funds are designed to mimic a certain market index and mirror its performance. Think back to the S&P 500 Index alluded to earlier. These funds will just follow what the market index fund is doing.
Although these are good ways to get an idea of if your 401(k) is managed, there are no rules saying fund managers can only use mutual funds and nothing else. So the final way to really know if it’s actively managed is to read the fund’s prospectus that you’re invested in. The prospectus will tell you everything you need to know about whatever fund you’re allocating money to, including how it’s managed.
Can I Manage My Own 401(k)?
Most employer-sponsored 401(k) do not have the option for their employees to manage their own 401(k) accounts. Roughly 20% of employers offer self-directed 401(k) plans, where you can invest in whatever securities, funds, and any other type of investment that you want. But that of course means that the vast majority of employers — about 80% — do not offer their employees this option.
However, almost all 401(k) plans do give you some control over what your money is being invested in. Most 401(k) have a variety of different funds and investment options that you can choose from. You might be able to invest in funds that aim to follow the S&P 500. There might be an option that follows more small-cap companies if you have a bit bigger risk appetite. And there might be funds that are far more conservative for those more risk-averse.
Should I Switch to an IRA for More Control?
If you want to have full control over your own retirement plan, though, you might want to consider switching some — or all — of your retirement savings to an IRA. Within an IRA, which is an Individual Retirement Account, you have complete control over what investments you’re putting your money into. Keep in mind, however, if you decide to go with an IRA instead of using your employer-sponsored 401(k), you could be missing out on some benefits.
The biggest benefit you would lose out on is the potential 401(k) match offered by your employer. If you opt-out of their 401(k) plan completely, then you won’t be able to get any additional funds from your employer as part of their match. This means you’d essentially be giving up free money by not using their plan. So if you still want to have full control by using an IRA, make sure you contribute at least enough to the 401(k) to get the match. You won’t be able to get a guaranteed 100% return anywhere else on the market!