A 401(k) retirement plan remains one of the most popular ways to invest for your golden years, and Americans have put away trillions of dollars in them. Despite this popularity, many workers don’t know how to best use the plans, and they remain stuck in conservative investments such as bond funds or even cash-like funds that often barely keep up with inflation, if they even do.

“The biggest financial mistake people make is taking too little risk, not too much risk,” says Robert Johnson, finance professor at Creighton University’s Heider College of Business.

Here’s how to check if your 401(k) plan is too conservative and what you can do to fix it.

What is a conservative 401(k) investment?

When retirement experts talk about a 401(k) portfolio being too conservative, they mean how much is invested in bond funds or cash-like alternatives versus stocks – what’s called asset allocation. If all or almost all of your retirement account is in bonds or CDs, it’s conservative. The returns on bond or cash-like investments are typically safe but not high, and they may not even outpace inflation, which the Federal Reserve wants at about 2 percent annually, though it’s been higher than that recently.

If you’re not earning at least the inflation rate annually, you’re actually losing purchasing power over time. That’s a serious problem if you want to use your 401(k) to make your golden years into something truly golden. That’s really the key issue with having a 401(k) that’s too conservative.

One way to achieve higher growth and become more aggressive is to add stock funds, or a higher allocation to stock funds, to your 401(k). Stock funds will fluctuate more in the short term than bond funds, but they’re more likely to deliver higher returns over time. The average annual return on the S&P 500, a collection of hundreds of companies, has been about 10 percent over long periods.

While it can make sense to become more conservative as you’re nearing retirement and need to access the money, you can probably afford to add a little more risk to your portfolio in exchange for a potentially higher return if you have at least five years. If you have a decade or more, you can allow the short-term fluctuations of stock funds to work themselves out.

“Broadly speaking, the younger the saver, the more aggressive they can be by having a larger percentage of their 401(k) balance in stocks,” says Rob Comfort, president of CUNA Brokerage Services Inc. “This can be a prudent choice for younger investors since they have many years before retirement to ride out the inevitable ups and downs of the market.”

But some workers make the opposite mistake, taking too much risk by running with a higher percentage of stock funds right up until retirement – one of the signs of being too aggressive.

3 signs your portfolio is too conservative

Below are some signs you might spot if your portfolio is too conservatively positioned.

1. Your portfolio doesn’t seem to grow

You’re adding to your 401(k) with each paycheck, but it doesn’t seem to grow much beyond that? That could be one of the clearest signs that you’re not being aggressive enough.

“If the portfolio is not growing over a meaningful period of time, it’s probably too conservatively allocated,” says Randy Carver, president and CEO at Carver Financial Services in the Cleveland area. He suggests looking at the performance over a longer period.

A few months or even a year may not give you enough perspective, however, since stocks can fluctuate significantly. You’ll want to factor out the short-term effects that stock funds may be having on your portfolio balance.

2. Your 401(k) has a hefty allocation to bond funds

A big allocation to bond funds could make your portfolio too conservative, especially depending on when in your life you’re over-allocated. By missing out on higher growth early on and the power of compounding, you seriously hurt your potential portfolio 20, 30 and 40 years later.

“Being over-allocated to bonds early in your investment career could have (negative) effects,” says Chris Keller, partner at Kingman Financial Group in San Antonio. He points to the difficulty of bonds staying ahead of inflation over time.

A big allocation might be anything over 50 percent allocated to bonds, but it really does depend on your age and when you plan to tap your money. As you get closer to retirement, it becomes more prudent to shift to a higher percentage of bond funds.

However, not all bond funds are the same, and some aim for safe but low yields in government bonds or high-grade corporate bonds. Other funds are trading in and out, taking advantage of pricing trends and ultimately delivering a higher yield. So it’s important to note the distinctions, because some bond funds may be adding an extra (valuable) risk to your portfolio.

3. Your 401(k) invests in a money market fund

Money market funds often earn little. The presence of these very safe funds could be a good sign that you’re too conservative, unless you’re right up on retirement age and you anticipate needing the money shortly, say, in the next year.

“Someone with a long time horizon should not have exposure to money market instruments, yet many investors do because they fear the volatility of the stock market,” Johnson says.

So even if you are at retirement age, you don’t want to move entirely into conservative investments, since you will be drawing on your 401(k) for many years into retirement.

Disadvantages of being too conservative with your 401(k)

Having a 401(k) portfolio that’s too conservative can come with a number of disadvantages, with the major downside being that you lose purchasing power over time. Here are some other common drawbacks:

  • Your portfolio never seems to move higher. If you’re investing primarily in low-return investments such as bonds or CDs, your portfolio will move up but only very slowly. So you may not be able to amass as much as you could by adding in some stock funds.
  • You lose purchasing power. If your investments are not outearning the inflation rate, you’re losing purchasing power over time. You can save money furiously, but you’re still not gaining on inflation.
  • You reduce your long-term returns. Investing in bonds and CDs may feel safe, but they deliver lower long-term returns than investments such as stocks and stock funds. So bonds are fine when you need to be conservative, but they hurt long-term growth.
  • You’re highly exposed to inflation. If your portfolio is all bonds, you’ll be highly exposed to inflation. As inflation rises, you’ll not only lose purchasing power but inflation may cause your bond investments to decline until it’s under control.

Those are some of the largest disadvantages of being too conservative in your 401(k).

What you can do if your portfolio is too conservative

The key fix for a conservative portfolio is to trade some of your portfolio’s bond funds for stock funds. But how much? That depends a lot on your time horizon. Investors with decades until retirement can afford to take more risk, and history shows that they’ll be rewarded over time.

Some advisors use the rule of 100 to gauge how much to invest in stock and bond funds. With this rule, you subtract your age from 100 to get your stock allocation, with the remainder going into bonds. For example, a 40-year-old should have a 60 percent exposure to stocks and 40 percent to bonds, while a 65-year-old should have 35 percent in stocks and 65 percent in bonds.

It’s a rough guide, but importantly it starts out more aggressive when you’re young and adjusts to be more conservative as you age – the type of allocation trend that you generally want. But don’t think that when you hit retirement you can go all bonds.

Carver cautions investors to remember that they’re likely going to need their money to last for probably at least two decades after they retire. Therefore, they need to maintain some growth in their portfolio, meaning they need at least some allocation to stock funds.

That’s why the rule of 100 is often criticized as being too conservative, and some advisors suggest that it be modified to the rule of 110 or 120. If the number were moved higher, retirees would maintain more of their portfolios in stock funds, giving them the potential for more growth over the long term.

If you’re looking for a “do it for me” solution, a good option is a target-date fund. You pick a fund based on when you need the money, and the fund maintains a more aggressive portfolio when you’re younger and gradually becomes more conservative as you age. Like the rule of 100, these funds give you a more appropriate allocation based on when you need the money.

If you need more personalized advice, your best bet is to hire a fee-only fiduciary advisor.

“Working with an investment professional can be a great first step as they will have tools and knowledge to help you understand the appropriate allocation based on your specific situation,” Comfort says.

Need expert guidance when it comes to managing your investments or planning for retirement?

Bankrate’s AdvisorMatch can connect you to a CFP® professional to help you achieve your financial goals.

Bottom line

“The surest way to build true long-term wealth for retirement is to invest in the stock market,” Johnson says.

While you don’t need to have your whole portfolio in stocks, it’s important to have a sizable allocation to them so that your 401(k) can grow and support you in your retirement years. Being too conservative with your investments, particularly early in life, can harm even savers with the best intentions, unfortunately.

Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.