Navigating 401(K) Investments: A 6-Year Plan For Post-Retirement Financial Security

Your 401(k) is the largest component of your retirement plan. Investing it is the next step after finding the money to save in the account. Investors who have decades to save should take more risk early on and gradually dial it down as retirement approaches. As a rule of thumb, you can subtract your age from 110 or 100 to find the percentage of your portfolio that should be invested in equities; the rest should be in bonds. Another option is a target date fund, which is available in virtually all 401(k)s.

Asset allocation

One common strategy is to use a rule of thumb to determine your asset allocation. This involves subtracting your age from 110 or 100 to find the percentage of your portfolio that should be invested in equities, with the rest in bonds. For example, a 30-year-old might invest 90% of their portfolio in equities, while a 70-year-old would invest 50%. However, it's important to consider your risk tolerance and how you'll react to market volatility.

Another approach is to use a target date fund, which is available in most 401(k) plans. These funds have a year in their names and are designed to correspond to the year you plan to retire. For instance, a 30-year-old might choose a 2050 fund, which diversifies and automatically reduces risk as the retirement year approaches. Alternatively, you can consider using a robo-advisor or an online planning service for personalized investment advice.

It's crucial to remember that uninvested money can lose value over time. For instance, $10,000 could be worth less than half that in 30 years, factoring in inflation. Therefore, it's essential to put your retirement savings to work through careful asset allocation.

Additionally, it's recommended to evaluate your income sources post-retirement and aim to replace around 80% of your pre-retirement income. This can help you determine the required balance from your 401(k) to achieve the desired income replacement.

Risk tolerance

Investors who have decades to save should take more risk early on and gradually dial it down as retirement approaches. As a rule of thumb, you can subtract your age from 110 or 100 to find the percentage of your portfolio that should be invested in equities; the rest should be in bonds. Using 110 will lead to a more aggressive portfolio; 100 will skew more conservative. Of course, a rule of thumb doesn’t take other factors into consideration — namely, your risk tolerance. Consider how you'll react if the market gets rocky and your portfolio begins to lose value.

Nothing is more central to your retirement plan than your 401(k). It represents the largest chunk of most retirement nest eggs. Finding the money to save in the account is just step one. Step two is investing it, and that’s one place where people often get tripped up. Some people think investing is too risky, but the risk is actually in holding cash. That’s right: You’ll lose money if you don’t invest your retirement savings. Let’s say you have $10,000. Uninvested, it could be worth less than half that in 30 years, factoring in inflation.

One is a target date fund, available in virtually all 401(k)s. These funds have a year in their names, designed to correspond to the year you plan to retire. If you’re 30, you might pick a 2050 fund. You put all of your 401(k) money in this fund, which diversifies for you and automatically takes less risk as you approach that year. Another option, which may be superior to a target-date fund, is a robo-advisor or an online planning service. Some robo-advisors will weigh in on or answer questions about your 401(k). Online planning services, including many of the ones on our list of the best financial advisors, offer low-cost access to human advisors and provide comprehensive guidance on your finances, including how to invest your 401(k).

As a general rule of thumb, many financial advisors recommend having enough saved in retirement funds plus other sources of income, such as Social Security benefits or a pension, to replace 80% of your income before retirement. If you have determined how much you will receive from other sources of income, you can use a conservative estimate of roughly 5–6% in annual returns from your 401(k) to figure out what sort of balance you will need to generate the additional income to achieve 80%. If you invest 401(k) money at a 7% return, you’ll have over $75,000 by the time you retire — and that’s with no further contributions. (You can use our 401(k) calculator to do the math.) Clearly you’re better off putting your cash to work. But how? The answer is a careful asset allocation, the process of deciding where your money will be invested.

Target date funds

The key advantage of target date funds is that they simplify investment decisions by automatically adjusting your asset allocation as you age. As you get closer to your target retirement date, the fund will gradually shift towards more conservative investments to preserve your capital and ensure a steady income stream during retirement.

When choosing a target date fund, it's important to select one that aligns with your retirement year and risk tolerance. For instance, a 30-year-old might opt for a 2050 fund, while a 50-year-old might choose a 2040 fund. The fund's name indicates the year it's designed to be invested until, and the asset allocation will gradually change over time.

Additionally, consider the average life expectancy and inflation rates when making your investment decisions. Financial advisors often recommend having enough savings and other income sources to replace around 80% of your pre-retirement income. This means you should aim for a conservative estimate of 5-6% annual returns from your 401(k), which will help you achieve the desired income replacement rate during retirement.

In summary, target date funds are a convenient and effective way to invest your 401(k) savings for 6 years before retirement. They offer diversification, risk management, and a clear path towards your retirement goals. By selecting the appropriate fund and understanding your risk tolerance, you can make informed investment decisions that will secure your financial future.

Robo-advisors

One way to decide how to invest your 401(k) is to use a target date fund, which is available in virtually all 401(k)s. These funds have a year in their names, designed to correspond to the year you plan to retire. If you’re 30, you might pick a 2050 fund. You put all of your 401(k) money in this fund, which diversifies for you and automatically takes less risk as you approach that year.

Another option, which may be superior to a target-date fund, is a robo-advisor or an online planning service.

Investors who have decades to save should take more risk early on and gradually dial it down as retirement approaches. As a rule of thumb, you can subtract your age from 110 or 100 to find the percentage of your portfolio that should be invested in equities; the rest should be in bonds. Using 110 will lead to a more aggressive portfolio; 100 will skew more conservative.

Nothing is more central to your retirement plan than your 401(k). It represents the largest chunk of most retirement nest eggs. Finding the money to save in the account is just step one. Step two is investing it, and that’s one place where people often get tripped up. Some people think investing is too risky, but the risk is actually in holding cash. That’s right: You’ll lose money if you don’t invest your retirement savings. Let’s say you have $10,000. Uninvested, it could be worth less than half that in 30 years, factoring in inflation.

If you have determined how much you will receive from other sources of income, you can use a conservative estimate of roughly 5–6% in annual returns from your 401(k) to figure out what sort of balance you will need to generate the additional income to achieve 80% of your income before retirement.

Employer contributions

One common type of employer contribution is a matching contribution, where the employer will match a certain percentage of your contributions up to a certain amount. For example, if your employer offers a 50% match on your contributions up to 6% of your pay, you should contribute at least 6% of your pay to receive the full match.

Another type of employer contribution is a profit-sharing contribution, where the employer will contribute a percentage of the company's profits to your 401(k) plan. This type of contribution is typically based on the company's performance and may vary from year to year.

It's important to note that employer contributions are typically subject to tax withholding, and you may be required to pay taxes on the contributions when you retire. Additionally, employer contributions may be subject to different tax rules than your personal contributions, so it's important to understand the tax implications of each type of contribution.

When planning for retirement, it's important to consider the potential impact of employer contributions on your overall retirement income. You may want to consult with a financial advisor to determine the best way to maximize your employer contributions and ensure that you have a stable source of income in retirement.

Frequently asked questions