retirement

How to allocate 401(k) assets

 

 

What do you mean, allocate my assets? Sounds personal.

OK, you have been at your new company six months and have just been handed a folder from HR that outlines the company's 401(k) plan. Now what?

Follow this three-step process.

Step 1: Assess your time horizon. You are saving for retirement, which may be many years, even decades, down the road. The longer the time you have before retirement, the more aggressive you can afford to be in your investments. What you invest in in your 20s is different than what you would invest in as you approach 40.

Step 2: Before you make decisions, you need to understand the relationship between risk and return.

If you want to get the best return on your money, you'll have to take more risks. Not comfortable taking risks? Then to sleep better at night, you'll have to settle for lower returns. Another reason for starting earlier.

Step 3: OK, so you have assessed your timeline and understand your risk/return relationship. Now, which investments do you pick?

Start by looking for funds that have lower expenses. The lower the fund's expenses, the more you have to invest.

There are two basic types of funds.

Index funds and actively managed funds. Index funds are designed to track the market index. 'What's a market index?' you ask. It's a slice of the stock market. For example, the Standard & Poor's 500 index contains 500 large U.S. companies.

Think of index funds as kind of like being on autopilot. They are not run by an active portfolio manager, so the expenses are lower.

Actively managed funds have a portfolio manager who is calling the shots, buying and selling stocks based on an investment strategy. The expenses are higher, and guess what? These funds tend to underperform their target indexes over time. Chances are, you will not get what you pay for. Meaning, higher expenses generally don't translate into higher returns.

Insider tip:
Because markets are inherently unpredictable, even seasoned fund managers have a hard time picking the right investments. Eighty-five percent of active mutual funds underperform their target over time.

So assess your time frame, understand your “risky” comfort zone, and invest your money. Just that simple.

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