Navigating Your 401(K) Choices: A Guide To Smart Investment Decisions

401k investments can be risky and returns are never guaranteed, but it can be more risky to keep too much of your savings in cash due to inflation. You should determine an appropriate asset allocation to reduce risk and maximise returns. This involves deciding how much of your investments will be in stocks and how much will be in safer investments, like bonds. Stocks have the potential for greater returns, but can be more volatile than bonds. Bonds are more stable, but offer potentially lower returns over time. Financial advisors often recommend using the following formula to determine your asset allocation: 110 minus your age equals the percentage of your portfolio that should be invested in equities, while the rest should be in bonds.

Asset allocation - stocks vs bonds

When deciding how to invest your 401(k), it's important to consider the risks and potential returns of different investment options. One key aspect of this decision is asset allocation, which involves determining the percentage of your portfolio that should be invested in stocks (equities) and bonds.

Stocks, also known as equities, have the potential for greater returns but can be more volatile than bonds. This means that stock prices can fluctuate more significantly over time, leading to higher potential gains or losses. On the other hand, bonds are generally considered "safer" investments because they offer more stable returns over time. However, it's important to note that bonds may provide lower returns compared to stocks in the long run.

A common strategy to determine your asset allocation is to use a formula suggested by financial advisors. This formula is based on your age and expected retirement date. The formula is: 110 minus your age equals the percentage of your portfolio that should be invested in equities, while the rest should be in bonds. For example, if you are 45 years old and planning to retire at 60, you would have a 15-year time horizon until retirement. This means you should invest a certain percentage of your portfolio in stocks and the remaining percentage in bonds, based on the formula.

It's worth noting that this asset allocation strategy may need to be adjusted over time as your circumstances change. For instance, as you get closer to retirement, you might want to rebalance your portfolio by increasing your bond allocation to conserve capital and ensure a steady income stream during retirement.

Additionally, when deciding on your 401(k) investments, it's essential to consider the type of investment options offered by your employer's plan. Common options include mutual funds, which are professionally managed investments that allow you to diversify your portfolio across multiple companies. Another option is annuities, where you make payments to an insurance company in exchange for a promise of steady income during retirement.

Time horizon - retirement date

When deciding how to invest your 401(k) funds, it's important to consider your time horizon, which is the amount of time until your retirement date. This is a crucial factor in determining your asset allocation, or the percentage of your portfolio that should be invested in stocks (equities) and bonds.

For example, if you are currently 45 years old and planning to retire at 60, you have a 15-year time horizon until retirement. This means you can afford to take on more risk with a higher allocation of stocks in your portfolio. As you get closer to retirement, you may want to rebalance your portfolio to include more stable investments like bonds to protect your savings from market volatility.

It's also important to consider the type of investment options offered by your 401(k) plan. Mutual funds are a common choice, as they are professionally managed investments that allow you to pool your money with other investors. This diversification can help reduce risk compared to investing in individual stocks.

Additionally, if your 401(k) plan includes an employer match, it's important to invest enough to receive the full match. This is a great way to boost your retirement savings and reach your retirement goals faster.

In summary, when deciding how to invest your 401(k) funds, consider your time horizon and adjust your asset allocation accordingly. Choose investment options that align with your risk tolerance and take advantage of employer matches to maximize your retirement savings.

Diversification - mutual funds

Mutual funds are professionally managed investments that allow investors to pool their money together to invest in dozens, sometimes hundreds of companies at once. With mutual funds, you don’t have the same amount of risk that comes with single stocks. Instead, you’re spreading your investments across many different companies with built-in diversification.

Bonds are more stable, but offer potentially lower returns over time. Financial advisors often recommend using the following formula to determine your asset allocation: 110 minus your age equals the percentage of your portfolio that should be invested in equities, while the rest should be in bonds.

Stocks have the potential for greater returns, but can be more volatile than bonds. You'll want to determine an appropriate asset allocation, or how much of your investments will be in stocks (also known as equities) and how much will be in "safer" investments, like bonds.

Annuities are one of the options on your employer’s 401(k) plan. The basic idea of an annuity is that you make payments to an insurance company, and in return they promise to grow your money and send you payments when you retire, giving you a steady stream of income throughout your retirement.

All investing is risky and returns are never guaranteed, but it can actually be more risky to keep too much of your savings in cash, thanks to inflation. Still, you don't want to go all in on one stock or investment, particularly if a rocky market makes you uneasy and anxious, or likely to do something drastic, like pull your money out of your account.

Employer match - company stock

If your 401(k) comes with an employer match, it’s a great benefit that will help you reach your retirement goals that much faster. When you’re ready to invest (that means you’re debt-free with a fully funded emergency fund), you should invest enough in your 401(k) to receive the full match. That’s an instant 100% return on your money! Some plans let you decide how to invest your employer’s matching contributions, but others leave it up to the employer, so they may offer you matching contributions in company stock.

Stocks have the potential for greater returns, but can be more volatile than bonds. Bonds are more stable, but offer potentially lower returns over time. Financial advisors often recommend using the following formula to determine your asset allocation: 110 minus your age equals the percentage of your portfolio that should be invested in equities, while the rest should be in bonds.

The second strategy to consider for investing the money in your 401(k) is the do-it-yourself route: to invest in the percentage of stocks and bonds that is appropriate for your circumstances (keep in mind that this ratio will likely change over time). To determine the correct ratio of stocks to bonds, we typically start where a target date fund starts – your expected retirement date. Your expected retirement date can be used to determine your time horizon. For instance, someone that is currently 45 years old and is planning to retire at age 60 would have a 15-year time horizon until retirement.

Mutual funds are the most common type of investment choice offered by 401(k) plans, and with good reason. Mutual funds are professionally managed investments that allow investors to pool their money together to invest in dozens, sometimes hundreds of companies at once. With mutual funds, you don’t have the same amount of risk that comes with single stocks. Instead, you’re spreading your investments across many different companies with built-in diversification. You might find annuities as one of the options on your employer’s 401(k) plan. The basic idea of an annuity is that you make payments to an insurance company, and in return they promise to grow your money and send you payments when you retire, giving you a steady stream of income throughout your retirement.

Inflation - cash

Inflation can make cash investments risky. Financial advisors recommend using the formula 110 minus your age equals the percentage of your portfolio that should be invested in equities, while the rest should be in bonds. Stocks have the potential for greater returns, but can be more volatile than bonds. Bonds are more stable, but offer potentially lower returns over time. Mutual funds are professionally managed investments that allow investors to pool their money together to invest in dozens, sometimes hundreds of companies at once. With mutual funds, you don’t have the same amount of risk that comes with single stocks. Instead, you’re spreading your investments across many different companies with built-in diversification. Annuities are another option on your employer’s 401(k) plan. The basic idea of an annuity is that you make payments to an insurance company, and in return they promise to grow your money and send you payments when you retire, giving you a steady stream of income throughout your retirement.

Frequently asked questions