I encountered a big problem when I first started investing. Maybe you’ve encountered it, too. I would read a lot of books on investing. Two of my favorites are Rick Ferri’s All About Asset Allocation and William Bernstein’s The Four Pillars of Investing. These books cover asset allocation, and in All About Asset Allocation, describe specific portfolios using Vanguard funds (I interviewed Rick Ferri in a previous podcast).
I quickly became a big fan of Vanguard funds. I mapped out my asset allocation—how much in stocks, bonds, domestic and foreign–and the Vanguard Funds for each asset class. Then I headed on over to my 401k and of course none of those funds were available in my employer’s plan. Not a single one of them. And to make matters worse, I would look at the list of mutual funds in my 401k and I had no idea how to select a fund.
An investor can open an IRA at most brokers or mutual fund companies. This flexibility allows you to invest your money however you’d like. With your 401(k), however, you’re stuck with whatever investments your employer decides to include in the plan.
In this article we’ll address that problem. We are going to cover how to compare mutual funds and even cover some online tools you can use to help in the process. While you may not have access to the fund you want in your 401k, you should be able to find some funds that are at least comparable to the mutual funds you wish were in your retirement account at work.
How Many People Pick Mutual Funds
So let’s first talk about how many people pick a mutual fund. You log into your 401(k), you look at the funds and what do they show you? They show you the performance. One year performance, 3 year, 5 year, 10 year, and maybe even since inception. Then you start comparing them side-by-side. Why not just pick the one that’s got the highest performance? Why would you pick one that’s got the lower performance?
So you pick the mutual fund based on past performance. I know you do it. I’ve talked to so many people who have picked funds this way, and I even took this approach in the early days. It’s an easy approach, and why in the world would you pick a fund that seems to have underperformed in the past?
The problem, as we all know, is that past performance is no guarantee of future returns. If we don’t focus entirely on returns, what do we look at?