This Is How To Choose Your 401(k) Investments, According to Dave Ramsey

©Dave Ramsey

Commitment to Our Readers

GOBankingRates' editorial team is committed to bringing you unbiased reviews and information. We use data-driven methodologies to evaluate financial products and services - our reviews and ratings are not influenced by advertisers. You can read more about our editorial guidelines and our products and services review methodology.

20 Years
Helping You Live Richer

Reviewed
by Experts

Trusted by
Millions of Readers

Participating in a 401(k) is perhaps the most powerful retirement investment you can make, especially in today’s age, when pension plans have all but vanished. Among the advantages of participating in a 401(k), is the boatload of money you save in taxes, as 401(k) contributions are taken out of your paycheck before taxes, meaning your gross income is reduced, resulting in less income taxes owed.

Though 401(k)s can be pretty low maintenance, you should wisely choose your investments — otherwise the funds will be kept in a money market account. But how do you choose such investments? In a new post on his blog, Ramsey Solutions, financial guru Dave Ramsey shared some savvy suggestions

Also here are 11 401(k) mistakes you should avoid.

Learn About Your Investment Options

When embarking on selecting investments for your 401(k), your first step should be to learn about your options. You can find these in the brochure or booklet that comes with your company’s plan.

“Your brochure or booklet will probably include at least three or four investment choices as part of your company’s plan, but you could even see a dozen or more — plus several alternatives to those pre-packaged options,” Ramsey said. “They may offer you anything from company stock to variable annuities to mutual funds.”

Next, Ramsey went over the basics of common investment options you might see on your employer’s plan. 

Target Date Funds

“Chances are your company plan’s brochure or booklet makes a big push for target date funds,” Ramsey said. “Target date funds are mutual funds that have predetermined investment mixes depending on the date you plan to retire. You’ll start out with a decent mix of growth stock mutual funds, but as your retirement date gets closer, the mix will become more and more conservative.” 

Ramsey isn’t a fan of these, noting that by the time you’re ready to retire, your 401(k) will be mostly invested in bonds and money markets. What’s wrong with that? 

“[It] won’t give you the growth you need to support you through 30-plus years of retirement,” Ramsey said. 

Company Stock and Employee Stock Purchase Plans (ESPPs)

If you work for a publicly traded company (aka anything that you can buy stock in), you may have the option of investing in your company’s stock. 

“You may even be offered an ESPP (employee stock purchase plan), either when you start or after you’ve worked at your company for a certain period of time,” Ramsey said. “An ESPP allows employees to buy company stock at a discount through a payroll deduction.”

Ramsey is quick to note that though a discount sounds amazing, it’s best to pump the brakes before making a move here. 

“Remember company stock and ESPPs are single stocks and we never recommend investing in single stocks for retirement,” Ramsey said. “Putting all your eggs in one basket when it comes to the stock market is risky, even if that basket is the shiny new company you work for.”

These are the better options, according to Ramsey:  

Mutual Funds

It is impossible to explain mutual funds in one paragraph, but Ramsey does a good job of briefly summarizing their role in 401(k) plans. 

“They’re the most common type of investment choice offered by 401(k) plans and with good reason,” Ramsey said. “Mutual funds are professionally managed investments that allow investors to pool their money together to invest in dozens, sometimes hundreds of companies at once.”

Ramsey also explained how mutual funds carry less risk than single stocks because “you’re spreading your investments across many different companies with built-in diversification.”

Annuities

Not all 401(k) plans have them, but many do: annuities. What are they? Let’s turn that question over to Ramsey. 

“The basic idea of an annuity is that you make payments to an insurance company and in return they promise to grow your money and send you payments when you retire, giving you a steady stream of income throughout your retirement,” he said.

“Fixed annuities are just what they sound like — a glorified savings account with a fixed interest rate (currently 5% or less),” Ramsey said. “Sounds easy and predictable, but that low rate of return won’t stand a chance against the rate of inflation.”

Things get a little more complicated when it comes to variable annuities, another type.  

“They’re basically mutual funds under the umbrella of an annuity,” Ramsey said. “And those payments you’ll receive throughout retirement will depend on the performance of those mutual funds — that’s why they’re called variable.”

Though Ramsey prefers these to fixed annuities, he does not recommend them, either. 

“Too many fees! Seriously,” Ramsey said. “You could be paying commissions, insurance charges, rider charges, investment management fees and surrender charges with annuities. No thanks! We’ll pass.”

Look Into Growth Funds 

Growth funds are usually affiliated with big companies that you’ve likely heard of. Ramsey has a more approving view of these, as he says they “will create a stable foundation for your portfolio.” He recommends allocating 25% of your investments to growth funds. 

Note that growth friends are different from “aggressive growth funds,” which often invested in “smaller, newer companies (like start-ups or small businesses), so there’s a little more risk involved, but the payoff could be bigger too.”

And then there are international funds. These too can be a strong player in your diversified portfolio of 401(k) investments.   

“Also called foreign or overseas funds, international funds are great for a couple of reasons,” Ramsey said. “First, they allow you to invest in non-U.S. companies. Secondly, they help spread out risk and diversify your portfolio.”

Lean On Professional Help

At the end of the day, this can be pretty complicated and possibly confusing terrain. When choosing your 401(k) investments, it’s best to get professional guidance. 

“A lot of people don’t know you can work with an outside professional to select your 401(k) investments, but you can,” Ramsey said. “Other investors worry that working with their own investing pro will be expensive.”

“Your investment professional may charge a one-time fee for a 401(k) consultation, and that’s a reasonable cost for the time they spend to help you make smart 401(k) selections,” he said. “Just make sure you know what to expect before your appointment so there are no surprises.”

Share This Article: