Your 401(K) And Index Funds

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Learn more about index funds to determine if they should be part of your 401(k) investment portfolio.

Most employer 401(k) retirement plans offer around 20 fund options to choose from. On average, employees participating in the plan invest in just three funds. When you select funds for your 401(k) plan[c1] , consider including an index fund.

 Index funds are mutual funds that track a market index like the Standard & Poor’s 500 (S&P 500). You are not purchasing part of an index, but rather the same components that comprise that index, such as stocks or REITs.

Here are the advantages to investing in an index fund as part of your 401(k) retirement plan:

1. Performance. Historically, index funds have outperformed managed mutual funds—especially those that follow large U.S. stocks and bonds. While the idea of a manager actively trading within a fund may sound appealing, the chances of that fund beating an index over the long term are slim.

2. Fees. The manager of an index fund is simply monitoring the index and ensuring that the portfolio matches as closely as possible. This means you’re saving the cost of paying an active manager, so the expense ratio of index funds is typically much lower. (However, it’s always a good idea to check the expense ratio of any fund before investing.)

3. Hands-off. Since these funds follow indexes, there’s not much you’ll need to do to manage your 401(k) plan. So if you don’t have the time, or don’t want to spend the time, researching different funds and stocks, an index fund might be the perfect choice. (That said, you should still rebalance your portfolio at least once a year to ensure you have the right asset allocation for your investment strategy.)

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With all the fund options available to you through your 401(k) plan—from money markets to stocks to bonds to target-date funds[c2] —it can be confusing to know which to choose. While this will depend on your risk tolerance, age and investment strategy, it’s a good idea to consider index funds as part of your 401(k) retirement plan.

This article contains general information. Individual financial situations are unique; please, consult your financial advisor or tax attorney before utilizing any of the information contained in this article.

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Source: Bankrate.com, Forbes, Investopedia, MoneyCrashers.com, CNN Money
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