||Ask the Dollar Diva
401(k) allocation for twenty-somethings
Dear Dollar Diva,
I am 26 years old and have the opportunity to
participate in my company's 401(k) plan with a 50 percent match.
My problem is not how much to invest, but where. There
are 12 different mutual funds to choose from, including index funds,
emerging growth, value, overseas, aggressive growth and bond funds.
At this point in my life, where should I allocate
should I allocate my money?" is the most important question
an investor can ask. Deciding on an asset allocation and rebalancing
your portfolio every year to keep the percentages where you want
them are the keys to maximizing returns and minimizing risk.
Before you can decide on an asset allocation for your
401(k) plan, you need to understand the three main mutual fund categories:
1. Investment objective: Conservative
or aggressive? Life's a trade-off.
Conservative investors trade lower returns for lower risk and preservation
of capital. Owning bonds is less risky than owning stocks, and owning
stocks in large U.S. companies is less risky than owning stocks
in small, foreign companies. The older you get, the more conservative
your investing should become.
Aggressive investors trade higher risks and periods
of high anxiety for higher returns. With a lifetime of investing
ahead of you, you can afford to take a more aggressive approach;
but you have to stay the course. The stock market is volatile; when
it takes a dive, you have to hold tight, believing it will follow
its historical pattern of bouncing back and moving forward in the
2. Investment style: Growth,
value or blend?
Growth funds look for companies whose sales and earnings are growing
faster than average; the stock price is usually expensive in relation
to current earnings. In other words, the price/earnings ratio (P/E
ratio) will be high.
Value style funds look for companies with stock prices
that are cheap, relative to their current earnings. In other words,
the P/E ratio will be low. Read the Diva's "What
is value investing?" for more on this investment style.
Blend funds use a combination of investment styles.
3. Size of company: Large-cap,
mid-cap or small-cap?
"Cap" means "capitalization." A company's market-capitalization
is its share price multiplied by the number of shares owned by investors.
Large-cap funds invest in large companies; mid-cap
funds in medium-size companies; small-cap funds in small companies.
For more on this, read the Diva's "What
is market capitalization?"
Before the Diva suggests an asset allocation for you,
here are some comments on the specific funds you asked about:
You need to understand what an "index" is before you can
understand what an "index fund" is:
- Index: An "index"
measures and reports the performance of a particular group of
stocks. It's a benchmark, or bogey, for the group it represents.
The benchmark for most mutual funds is the S&P 500.
- S&P 500 index:
This index measures the total change in market value of America's
500 most widely held public companies. The goal of most stock
mutual funds is to beat the S&P 500. Over the long haul, hardly
any of them do, so an S&P 500 index fund is a good place to
put your large-cap investment dollars.
- Index fund:
An "index fund" buys the same stocks that make up a
particular "index." Vanguard
is the 800-pound gorilla of index fund investing.
An index fund that mirrors the S&P 500 is a large-cap
fund, holding a blend of growth and value stocks. Expect your investment
in this type of fund to be boring, effortless and profitable.
There are indexes to measure every segment of the
investment market. To learn more, read the Diva's "You'll
need an index to do the job."
Emerging growth fund
An emerging growth fund buys stocks in companies in less-developed
countries, such as Mexico, Malaysia, Chile, Jordan, the Philippines
and Argentina. Because of the political and economic instability
of the emerging markets, these funds are volatile and risky.
Overseas funds buy stocks and bonds in foreign companies. Global
funds have a mix of U.S. and foreign holdings.
Aggressive growth funds invest in companies whose sales and earnings
are expected to soar in the future. These funds have periods of
huge losses and periods of huge gains; you're betting that over
time the gains will far outweigh the losses. You need a strong stomach
and long time frame to invest in this type of fund.
Bond funds invest in bonds. A conservative fund invests in U.S.
government bonds; an aggressive fund invests in high-yield or "junk
Suggested asset allocations
For more information on the various types of mutual
funds, visit the Morningstar
Web site. Morningstar is the leading provider of independent
data, analysis and editorial commentary on mutual funds.
Do yourself a favor and use the free Morningstar "Quicktake
Reports" to check out the mutual funds offered by your company's
401(k) plan. Among other things you'll learn the name and tenure
of the fund managers, what fees they charge, investment styles,
size of companies the funds invest in, performance data and risk/return
If this is too much information to digest before it's
time to make your first 401(k) contribution, don't despair: Put
the entire contribution in an S&P 500 index fund, or other large-cap,
blend fund, until you've had time to decide what allocation you're
going to feel comfortable with and what individual funds you wish
-- Posted: Nov. 1, 2001
-- Posted: Nov. 1, 2001