3 Tips for New 401(k) Mutual Fund Investors

By Markets Fool.com

Starting out as an investor can be pretty intimidating.

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Even though I was working in the financial industry, when I got my first 401(k) enrollment form I was totally overwhelmed. I probably spent the better part of a weekend trying to sift through all the investment choices, comparing mutual funds to index funds to lifestyle and target-date funds.

There's just so much information, not only about strategies and styles but about fees, performance, and risk. But when it comes right down to it, there are three key thingsyou should be paying the most attention to.

Fees, fees, fees
The easiest way to shoot yourself in the foot as an investor is to pay too much for the privilege of investing.

Fees are like a persistent headwind against your performance progress. Too strong a wind, and you're liable to stand still -- or even move backward.

That might sound obvious, but inattention to fees is a surprisingly common problem.

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A University of Pennsylvania Law School study found that over 68% of participants allocated money to an expensive mutual fund that was actually an exact replica of an available low-cost index fund.

Multiply that by the information-overload of investing in the real world, and you can see how this could be a big problem. Even a seemingly innocuous 0.5% fee difference each year can make a difference over the course of 30 years. Don't let it happen to you: be aggressive about finding the lowest-cost mutual funds you can find.

On that note, consider the boring route
Active management is really fun and kind of exciting. Even though it was "just" mutual funds, I was certainly pretending to chomp on a cigar and bark orders at my assistant a la Gordon Gekko when I put together my first portfolio (in my own way).

What I didn't realize at the time is that, for the vast majority of people, active management does more harm than good.

Not only is it expensive, it just doesn't really work.

Mix high fees with the low likelihood of consistently beating the market, and you usually end up defeating the purpose: according to one study, the Vanguard Total Stock Market Index outperforms its competitors around 77% of the time.

"In the long run this boring approach can give you more time for more interesting activities such as music, art, literature, and sports ... and it may very well leave you with more money as well." --William Sharpe

The index fund strategy also comes with the added benefit of letting you do something besides tinkering with your portfolio. In other words, it will help you avoid the temptation to overtrade, which, once again, runs up fees.

Which, as I may have mentioned, you'll want to avoid.

Diversify with intention
The same study above also noticed a persistent diversification problem. While some investors under-diversify, a far more common problem in the experiment was overdiversification. For example, over 65% of the participants invested in two funds which were literally identical, except for fees.

In other words, in the spirit of diversification the majority of participants added another fund but didn't add any value -- only more expenses.

Be prudent in your diversification by allocating to different asset classes, not just to different funds in the same asset class. Your portfolio could include a mix of international stocks, larger and smaller stocks, and of course bonds.

If you go the boring route, you might find a little diversification plan has already been made for you: there usually aren't a lot of index fund options, and the ones there are will probably cover a fair amount of territory.

So, have fun with your first portfolio, but keep your eye on the prize: more money for the long haul. Stick to these tips and you've taken the first step to getting there.

The article 3 Tips for New 401(k) Mutual Fund Investors originally appeared on Fool.com.

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