Best Funds for Investing in a 401(k)

Use These Funds Types in Your 401(k)

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Use these fund types for your 401(k). Getty Images

Which are the best fund types to use in a 401(k)?

When you look at your employer's 401(k) plan investment choices, you'll probably find around 10 or 12 mutual funds, that include three basic types: 1) Stock Funds, 2) Bond Funds and 3) Money Market Funds. If you have more than one account type, it may be wise for you to use some of these in the 401(k) and use other types elsewhere.

If you have a taxable brokerage account in addition to your 401(k), you'll want to keep the investments that generate the most taxes in the 401(k) and the investments that generate little taxes in the taxable account.

If all you own is the 401(k), you will allocate and invest in whatever way is appropriate for your goals and generally ignore this guidance (unless you are planning to open a taxable brokerage account in the near future).

Remember that earnings on investments held in retirement accounts, sometimes referred to as tax-deferred accounts, are not taxed until withdrawal; the tax is "deferred," meaning you pay it later rather than now.

Therefore you get to keep your earnings, dividends, and interest and earn interest on top that interest, and so on. In addition, there is no taxation of interest, dividends or gains while the investments are held in the 401(k). This allows for faster growth, thanks to the power of compounding interest.

To make your money work as hard as possible, be sure to locate the funds within your 401(k) that are taxed the highest and the funds that produce the most dividends and interest in your retirement accounts.

Therefore you want to keep dividend mutual funds, your bond funds and your aggressive growth funds in your 401(k). You can locate your index funds in your taxable accounts.

You may also consider how often you place trades for certain investments. For example, if you have a large gain from a particular mutual fund, and it's held in your 401(k), you won't pay any taxes on the capital gain realized when selling the fund.

Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.