You can slice your 401(k) portfolio to suit your taste.
Asset allocation is an investment strategy for spreading your money across asset classes or the mutual funds that invest in them. Market history shows that when one class of investments is performing poorly, others are often doing better. So by investing in a number of different classes, you may limit your risk and improve your chances of a higher long-term return.
Asset allocation is a three-step process:
- You sketch out the mix of asset classes you think is right for your portfolio.
- You assign a percentage of the portfolio’s total value to each class.
- You buy investments to fill in the percentages you’ve selected for each asset class.
For example, if you allocate 60% of your contribution to stock funds, and you put $400 from each paycheck into your 401(k), then $240 of each contribution goes into the stock funds ($400 x 60% = $240).
You can track 401(k) asset allocation. Your account statement reports the percentage of your total contribution that goes into each fund. And you can estimate whether the actual value of the different asset classes is in line with the allocation you’ve chosen by dividing the current value of each asset class by the total value of your account.
Current value of class / Total value of account = % of asset allocation
Which asset allocation should you choose? First and foremost, you need to consider your investment goals. If your target is maximum long-term growth, as it may be for most of the time you’re putting money into a 401(k) account, you may want to put the greatest emphasis on growth investments, specifically stock and stock funds. If you’re getting closer to retirement, you may want to gradually shift the proportion of stock and bonds or other fixed-income securities so that more of your assets are more stable in value and produce regular income.
Next, you might look at the asset allocation models that financial institutions recommend. They can give you a sense of what the professionals are thinking. Then work with your retirement adviser to design an allocation model that suits your age, retirement plans, and risk tolerance.
You can also create an allocation model using retirement planning software available from mutual fund companies and brokerage firms. Or you might try the retirement planning tools available on a number of financial websites.
There’s no right allocation
No single allocation model produces strong results in all economic climates, so firms suggest different models at different times. Even models suggested at the same time may differ from each other, sometimes subtly and sometimes significantly. Likewise, your strategy may differ dramatically from what other people are doing.
For example, conventional wisdom suggests that the further away you are from retirement, the greater the investment risk $600,000 $295,500 $435,500 $572,000 $290,681 $419,206 $534,083 $180,611 $291,776 $466,096 8% 500,000 400,000 300,000 200,000 10% RATE OF RETURN 60% 30% 30% 60% 30% 10% 5.5% 3% you can assume. This approach isn’t right for everyone, however.
Say you’re in your early 30s. If you were to follow the guidelines for people 30 or more years away from retirement, you might invest 80% or more of your 401(k) account in stock and stock mutual funds. But if the effect of a bear market — a sustained downturn in the value of stock — makes you very uneasy, you may choose to limit your stock allocation to 60% or less of your account.
On the other hand, suppose you’re in your 60s. According to conventional guidelines, you should have closer to 50% of your account invested in stock. But if Social Security, your pension benefits, and the part-time work you’re planning to do will cover most of your expenses right after retirement, you may want to be more aggressive with your 401(k) money.
So, you might invest a larger portion — perhaps 60% — in stock, with the thought that you can always reallocate later. In fact, unless your 401(k) is still in a former employer’s plan where you can’t make changes to the account, you’ll be able to adjust your allocation when you feel it’s important. Remember, you’re making a long-term commitment to saving for retirement, not to specific investments or asset classes.
Finding The Best Asset Allocation For Your 401k by Inna Rosputnia
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