Choosing the Best 401k Investment Portfolio Strategy

For many, making the most of a 401k might as well be an Olympic sport. With the selections ranging from company to company and provider to provider, the options for a solid retirement strategy can be both limited and varied – and occasionally both!

It is routine for 401k sponsors to offer a small selection of stock funds coupled with a large selection of fixed-income instruments, or vice versa. Thus, some investors may find that their selection is worse in their earlier years (when they want more equities) than it is in their older years (when they want more fixed-income). Amidst all of these choices, what is the best 401k investment portfolio strategy?

Basic 401k Investment Portfolio Strategy

Basic investment strategy tells us that investors should open themselves to more risk at a younger age and less risk as they reach retirement. This allows for the maximization of growth at a time when it can be most afforded, but a slow and steady climb in the years leading to retirement. This has been the foundation of the most prevalent 401k investment portfolio strategy for decades.

This very basic 401k investment portfolio strategy can be achieved with two very common financial products. These include target-date mutual funds and other index mutual funds.

Investment Portfolio Strategy
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401k Investment Portfolio Strategy with Target-Date Funds

Target-date mutual funds are designed to be an extremely simple retirement investment portfolio—all in one fund. The idea is that with regular contributions to a target-date fund, you’ll slowly see growth in your assets that corresponds with your selection of risk. Thus, when you are the furthest from retirement, the target date fund will hold mostly stocks. As you near retirement, the fund is automatically balanced so that you hold more bonds.

The benefit here is automation. Since the planning and investment strategy is done for you by an investment manager, your job is to make sure that you can contribute regularly and in amounts great enough to reach your financial goals. However, keep in mind that these funds, though popular, are some of the costliest.

Index Mutual Funds

Index mutual funds are another common 401k investment product which has a number of benefits over their target-date alternatives. For one, index mutual funds are very low fee and often cost only one-tenth that of a target-date fund. Also, they are easy to buy and sell, and they come in a variety of options for performance tracking.

Index mutual funds are designed to buy a whole market index at one time, the S&P 500 being the most popular index fund choice. When you buy an index fund, you are essentially purchasing all 500 stocks that make up the S&P 500 index, thus diversifying greatly with only one purchase. Alternatively, bond index funds allow investors to snap up a whole selection of bonds, thus diversifying their fixed-income investments across a variety of creditors.

The low cost and diversification of index mutual funds come at a price, however. You will have to balance your assets yourself, and it is your responsibility to decide the risk of each financial product.

As a rule of thumb, your age is the amount in percentage of your retirement assets that should be invested in fixed-income, while the remainder should be invested in stocks. Thus, someone who is 25 years old should own 75% stocks and 25% bonds.

Most often, those who use index funds outperform the results of target-date fund investors due to lower fees. However, a concern among many financial planners is that those who are actively engaged in making retirement decisions (as many are who use index funds) is that these investors will play around with their portfolios too much, and thus “chase” performance. Even though index funds require some activity on the end of the investor, rebalancing of portfolios should be done only once per year.
Tim Ord
Ord Oracle

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