Becoming Your Own Financial Advisor – Part 3


In part 1 and part 2 of this series, we talked about goals and general investment strategy with the goal of teaching you be to a self-directed financial advisor.

In part three we are going to focus on two of the types of investments you can add to your portfolio – 401(k) and Exchange Traded Funds or EFTs.

Investment Options – 401(k)

What is a 401(k)?

401(k)s are employer-sponsored plans that offer:

  • Automatic savings
  • Tax incentives
  • Matching contributions (if employer participates)

There are of course some pros and cons associated with 401(k) plans.

Some of the pros include:

  • Contributions may be tax deductible
  • Tax-deferred growth
  • Matching contributions
  • Possible to borrow from plan or use funds for “hardships”

Some of the cons include

  • Early withdrawal penalties
  • Annual contribution limits.

How can you invest in a 401(k)?

You will need to contact your employer’s human resources department.

Pro Tip: You will want to contribute at a level allowing you to fully leverage your employer’s match if your employer offers it. Failure to do so means you are leaving free money on the table.

The plans provided by your company, 401(k)s and other plans, are known as defined-contribution plans. This is because you – as an employee – contribute to the plan. This is normally done through regular payroll deductions.

It is up to you to decide how much to contribute, taken as a percentage of your salary. The contributions are then automatically deducted from each paycheck.

Depending on the company’s or organization’s structure, what is available to you in a defined-contribution plan can vary.

Here are some examples of defined-contribution plans.

  • 401(k) -public or private for-profit companies
  • 403(b) – tax-exempt and non-profit organizations
  • 457 – state and local municipal governments, some local and state school systems
  • Thrift Savings Plan (TSP) – U.S. government civil and military service

Plan Contribution Limits

The limits to contribution change periodically depending on cost-of-living index increases.

In the 2017 tax year the IRS allows for contribution up to $18,000 to a 401(k), 403(b) or TSP, and most 457 plans.

You can make a “catch-up” contribution if you are age 50 or over- $6,000 to any of the listed plans.

Matching Contributions For Plans

Your may have matching contributions as a perk to your employment. This has the power to dramatically increase the value of your retirement account.

Find out if you company has a match and how much it is. A common was that employers contribute to employee funds is via a percentage.

As an example, let's say you make $100k a year and contribute up to 5% of your salary – $5k – to your plan. If your company offers a 50% match, they’ll kick in another $2500 to your account.

Keep in mind that your employer’s contribution may be limited by the plan or by the annual contribution limit as set by the IRS.

Investment Options in Your Defined-Contribution Plans

Though you know the amount of your contribution, what you reap from that contribution- the benefit or retirement amount – is unknown. The benefit  depends on the performance of the investments.

How you invest the money that is contributed to the plan – both by you and your employer – is your decision. In most setups you get to choose from a variety of investments offered by the plan –

  • Mutual funds
  • Stocks
  • Bonds
  • Guaranteed investment contracts – not unlike certificates of deposit

If for some reason you aren’t thrilled with your investment options, you may be able to transfer part of your plan to another retirement account. This is something known as a partial rollover.

Of course as you select investments, consider your risk tolerance and investment time horizon. A nice rule of thumb is that you should invest more aggressively when you are younger – giving you more time to recover from any losses – and more conservatively as you approach retirement. Therefore you need to plan on changing your allocations as time progresses.

You can make changes to your allocations whenever you want for most 401(k)s. However some are limited – you can only make changes once a month or even once per quarter. Make sure you ask your employer if there are any caveats to allocation changes.

401(k) Investment Considerations – Expense Ratios

Something else that you will need to consider for your investments in a 401(k) are the expense ratios.

Investments such mutual funds and ETFs charge shareholders a fee – known as an expense ratio – to cover the fund’s total annual operating expenses which include cost for things such as administration, compliance, distribution, management, marketing, shareholder services, recordkeeping as well as other operational costs.

As you might guess, the expense ratio directly reduces your returns – and the value of your investment.  This means you cannot assume an investment reporting the highest return is automatically the best choice for your 401(k). A lower-returning investment that comes with a smaller expense ratio may yield more money in the long run.

401(k) Investment Vesting

While the money you contribute to a 401(k) is yours right away, funds from matching contributions are not 100% yours until you are fully vested.

Funds vest over time. So for instance you might be 25% vested after one year of employment, 50% vested after the second year and so on.

As you might suppose, once you become fully vested, all the money in your 401(k) is yours and it moves with you if you switch employers or retire.

401(k) Distributions

When you take an early withdrawal from your 401(k) or other qualified plan you – In most cases – will owe a 10% penalty tax if you do so before you are age 59½. .

There are some allowable exceptions to the 10% additional tax penalty and they include

  • You have a complete and permanent disability.
  • You have died. Distributions are made to your beneficiary or estate.
  • Your deductible medical expenses exceed 10% of your AGI (adjusted gross income (7.5% if you or your spouse are age 65+)
  • Military reservists called up for active duty.
  • You must make court-ordered spousal payments.
  • You are separated from service at age 55+, or age 50+ for public safety employees.
  • IRS levy
  • Substantially equal periodic payments (SEPP) as disbursements

You have to start taking distributions from your 401(k) by April 1 of the year after you turn 70½. – these are called required minimum distributions (RMD).

Afterward your RMDs are  based on your life expectancy and the value of your account –and these have to be made by Dec. 31 each year.

There is an exception to RMD rules. If you continue to work, you may delay taking RMDs from your 401(k) until April 1 following the year you retire. This exception holds unless you own more than 5% of the company that is the sponsor of the plan.

If you own more than 5% of the sponsoring company then, you still have to start RMDs after you turn 70½, whether or not you continue to work.

If you ignore the requirement for RMDs the penalty is substantial – you will be required to pay 50% federal tax on any amount you should have withdrawn in addition to your regular income taxes.

Investment Options – Exchange Traded Funds

Now let’s turn our attention over to Exchange Traded Funds (ETFs)

ETFs are uniquely structured investment funds that track broad-based or sector indexes, as well as commodities and baskets of assets.

There are of course some pros and cons to EFTs.

Some of the pros include –

  • Provide diversity in a single investment
  • Traded on a regulated exchange
  • Can be traded on margin
  • They have no short-selling restrictions
  • Low expense ratios
  • Some brokers offer commission-free trading
  • They are tax efficient

And here are some of the cons

  • Broker commissions can erode returns
  • Bid-ask spread can be large
  • Some ETFs may be subject to contango (a situation where the futures price of a commodity is above the expected future spot price)
  • Certain ETFs are taxed at a higher rate (for example those holding physical precious metals).

How to invest in EFTs

Here is a pro tip. Target-date ETFs are designed in a way to adjust allocations based on where you have set your target retirement date.

As an investor, target-date ETFs are an easy way to manage investments based on the number of years you have left until retirement.

There is only one decision you need to make on this type of ETF. You simply select the target-date fund that most closely matches the year you expect to retire.

With ETFs you are able to access nearly any asset class or sector. This gives investors the ability to gain exposure to markets that have traditionally been challenging to tap. For instance, commodities and emerging markets.

If you are interested in equities there are ETFs that target stocks, stock sectors, foreign stocks and emerging market stocks.

If you would rather have something that is fixed-income you have the option when using ETFs of trading broad-based U.S. funds, municipal funds, international bonds, Treasury funds and emerging market debt.

You can do the same with commodities.  Using ETFs you can access broad-based funds, agriculture, industrial metals, precious metals and energy.

Inverse and leveraged products

If you crave other variations of the ETF you can invest in inverse and leveraged products.

Inverse ETFs are constructed by using various derivatives with the purpose of profiting from a decline in the value of the underlying benchmark. This is counter what we normally think of when we think of profiting – we think of profiting from a rising market.

On the other hand leveraged ETFs  use derivatives and debt to magnify the potential returns –and potential losses as well- of an underlying index.

You can find many funds that are double or even triple leveraged. In addition there are some funds which are both inverse and leveraged at the same time.

As best practice it’s smart to steer away from leveraged ETFs unless you are very familiar with the way they work.

Pro Tips for Choosing ETFs:

Here are some quick tips when looking for ETFs
  • Decide which asset classes you want to invest in and consider your overall diversification
  • Look for ETFs that track those above asset classes you want to invest in
  • Compare the options in the ETFs
    • Examine expense ratios – less = better
    • Look at volume and assets under management – more = better
  • Buying and selling frequently? Find  brokers that offer commission-free trading for your desired ETFs

401(k) and Exchange Traded Funds Summary

In this article, we looked the investment options of 401(k)s and Exchange Traded Funds or ETFs.

In our upcoming articles we will explore other investment options that you may want to consider as you move toward your goal of being your own financial advisor.



  1. This is a very informative post, with lots of great tips on how to take advantage of the various investment options that are available to us. Thanks for compiling and sharing it all in one useful post 🙂

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