How Should You Pick Your 401K Investments?
How Should You Pick Your 401K Investments?
First, I will state unequivocally, there is no easy 1-page answer to this question. That being said, In this article, I will do my best to give you the tools you need to make the proper choices in your 401K.
Should I Invest In My Company?
You will get many different answers on this question from your friends and co-workers. Here is the bottom-line: You already have an enormous portion of your retirement linked to your current employer. Your income, and future income, are all linked to your current employer’s well-being. Think, for a moment, what would happen if your company went out of business. You would instantly lose your income, your future income, along with any stock options you held at the company. Isn’t that enough of an investment? Now, if someone were to have 50% of their 401K in their own company’s stock, they would also lose 50% of their retirement nest egg immediately. In my personal opinion, you have enough invested in your own company the day you begin working there, so you should not invest in your own company within your 401K.
NOTE: The one exception, that I would make sure to point out, is when you are offered a match on your company’s stock (and not on other investments), or when you have an opportunity to purchase the company’s stock at a discount to the current stock price. In these unique scenarios, it makes a lot of sense to temporarily hold your company’s stock for the duration required to obtain the benefit.
What Mutual Funds Should I Pick?
Again, this is not a one-size-fits-all kind of question. I will say that there are a variety of 401K plans that offer “Funds-of-Funds”. A few examples of funds like this are “Fidelity Freedom 2040” or “Vanguard Target Retirement 2025”. Basically, these funds hold a variety of other mutual funds on the inside. Their aim is to put together a balanced portfolio with the goal of retiring in the year that is stated. For example, the “Vanguard Target Retirement 2025” fund is for people who are aiming to retire in, or around, the year 2025. It will be comprised of a more conservative investment portfolio than the “Vanguard Target Retirement 2045” Fund. This is because as you grow older, you should slowly make your retirement fund more conservative to protect against large swings in the stock market. These funds will actually slowly rebalance their holdings in order to slowly get more and more conservative as you approach retirement. I am a huge fan of these funds for the average 401K investor. If you choose this route, you will probably want to invest 100% of your portfolio in one of these funds. Most of you probably have been told to never, ever invest “all of your eggs in one basket”. The difference here is that each of these funds holds approximately 10 mutual funds (or thousands of total stocks), so you are probably more diversified than you would be if you were to assemble your own portfolio.
If you would much rather construct your own portfolio, then you should diversify your portfolio according to your risk tolerance. Regardless of your asset class, you should invest a percentage of your 401K across all asset classes, including Large-Cap, Mid-Cap, Small-Cap, International, and Bonds. I am going to give very broad-based guidelines here so that you can begin to construct your own portfolio if you wish. I am going to split the suggestions into 5 age groups and risk tolerances. Please note that the age groups and risk tolerances do not necessarily fit together (as some people are more or less risky than others), but you should choose either the age bracket, or risk tolerance to make your decisions.
Aggressive Portfolio – Typical Age Range: 18 – 35
25% Small-Cap, 25% Mid-Cap, 35% International, 15% Large-Cap, 0% Bonds
Moderately Aggressive Portfolio – Typical Age Range: 35 – 45
15% Small-Cap, 15% Mid-Cap, 20% International, 30% Large-Cap, 20% Bonds
Moderately Conservative Portfolio – Typical Age Range: 45 – 55
10% Small-Cap, 10% Mid-Cap, 10% International, 40% Large-Cap, 30% Bonds
Conservative Portfolio – Typical Age Range: 55+
5% Small-Cap, 5% Mid-Cap, 5% International, 40% Large-Cap, 45% Bonds
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