5 Fundamentals for 401k Investing

401k’s have provided Americans with a great way to save for retirement. In fact, 401ks are one of the greatest retirement accounts in our day. Many employers have provided these accounts for their employees, and some even still provide matching opportunities.

Perhaps you’ve been investing in your 401k for a long time. Or, maybe you’re just starting out. Either way, the last thing you want to do is make some 401k mistakes!

At any rate, there are some fundamental strategies for investing in your 401k that should be considered.

Pay Attention to Your Time Frame

Time frame is fundamental to your 401k investing because if you have a long-term investment horizon (say for example you aren’t retiring for 20 years), you can afford to take on a little more risk.

For those who may have a shorter-term horizon (i.e. retiring in five years or less), you may want to start shifting more of your stock positions to bond positions to shore up what you have.

Pay Attention to Company Matching

I am amazed at how many folks I’ve talked to that simply don’t know what kind of match their company is offering. This results in leaving free money on the table.

If a company is matching dollar for dollar up to six percent, it doesn’t make sense to only put in three. At the very least we should be putting enough into our 401ks to take advantage of any money they are willing to give.

Pay attention to the details of your company‚Äôs matching program, and don’t leave any money on the table.

You may also want to consider a Roth 401k.

Pay Attention to Your Risk Tolerance

Wouldn’t it be great to make phenomenal returns without any risk? Of course it would! But that doesn’t happen. Understanding your risk tolerance is key to developing a proper investment strategy.

You need to understand your risk profile and how that impacts your decision-making with your 401k funds. Too many folks I’ve counseled label themselves a “conservative investor”, only to reveal their 401k funds are extremely aggressive.

If you like to roll the dice, you’ll be more comfortable with a higher stock position (which in theory offer greater returns over the long run), and those with a conservative bent will be more comfortable with less stock and more bonds.

For guidance in this area, here are five questions to help determine your risk tolerance.

Pay Attention to Your Investment Allocation

Related to risk tolerance is your investment allocation. Your allocation, or the mix of stocks and bonds, will be determined by your risk tolerance.

Generally speaking, you can think of a model portfolio along these shades of risk tolerance:

  • Conservative: 80% Bonds; 20% Stocks
  • Moderate Conservative: 65% Bonds; 35% Stocks
  • Moderate: 50% Bonds; 50% Stock
  • Moderate Aggressive: 35% Bonds; 65% Stocks
  • Aggressive: 20% Bonds; 80% Stocks

This is a very simplistic view of allocation, but it at least gives you an idea of where to start. You’ll want to consider other asset classes as your risk tolerance allows such as cash, real estate, commodities, etc.

Pay Attention to Rebalancing

Rebalancing simply refers to the act of bringing your target allocations back in line from where they’ve drifted. For example, let’s say you are a moderate investor according to our simplistic allocation from above. You should have 50% in bonds and 50% in stocks.

And let’s say that over this next six months stocks have a great run in the market, and now because of growth, your stock allocation increases to 60%.

If you sell off that 10% to lower your stock position back to 50% and invest back into bonds, that’s rebalancing. You simply try to keep your investment allocation in line with your model portfolio percentages.

You can rebalance based on a time frame (i.e. every six months, or annually); or you can rebalance based on an overweight or underweight percentage (i.e. if stocks vary by 5%, or bonds vary by 10% etc.)

The reason rebalancing is important is because it keeps you from becoming too overweight or underweight in any one particular category, which tends to increase your risk.

Follow these fundamentals to help make the most of your 401k investing, and help you achieve your retirement goals.

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  1. Jon

    An important aspect to remember about 401k investing is high fees. Many times, these fees are hidden within your employer’s programs. Read the fine print before you invest in your 401k plan.

    Also, with this economy, many employers have pulled their matching plans or increased the time-period required to keep vested amounts of money. Sometimes, it makes more sense to invest on your own!

    And remember, fully fund your Roth-Ira before investing in your 401k!

    Just my 2 cents!

  2. RcGarber

    Good comments on 401k’s.
    I personally like to track a great newsletter in this regard.
    http://www.soundmindinvesting.com is a great resource to no load mutual funds.
    They have bundled their upgrading in some of their own mutual funds under http://www.smifund.com
    Enjoy the day.