How to Pick an Asset Allocation for Your 401(k)

Think about your retirement goals and age when choosing investments in your 401(k) plan.

Pick an Asset Allocation for Your 401(k)

Make sure you have a good understanding of your risk tolerance before weighing the types of investments available for your 401(k) plan.(Getty Images)

Saving for retirement in a 401(k) plan provides tax advantages that can be helpful as you plan the future. Some employers match the contributions you make, up to a certain amount or based on other criteria, which enables your funds to grow further. The challenge of setting up a 401(k) plan is selecting an asset allocation, which refers to how you invest your contributions. You need to make a decision about whether to invest in stocks, bonds or other types of investments. For instance, you might have 50% of your contributions invested in stocks and 50% invested in bonds. You can typically change your asset allocation periodically.

When it comes to determining the right asset allocation for your 401(k) plan, it’s important to consider both the risks and rewards involved with different options. It can be helpful to understand what is available and the costs of each option. Use the following guidelines as you decide how to invest your funds in a way that fits your age, lifestyle and retirement goals.

Determine Your Risk Tolerance

The level of risk you are comfortable with can vary greatly from one individual to another. When evaluating your risk tolerance, “It’s important to take your emotions into account,” says Julian Schubach, vice president of wealth management at ODI Financial in Lynbrook, New York. “Consider how you would feel if your account suffered a 10% loss in a given period. Would you panic and stop making contributions? Would you continue to focus on long-term growth and make no reactionary changes?”

If you’ve been making contributions to retirement accounts for years, you can reflect on your reactions to changes in the past. For newcomers, starting with less risk might help you focus on understanding how the funds work. “Dip your toes into investing before diving straight into the water,” Schubach says. “Consider a conservative fund initially and if you feel you want to take on more risk, adjust your allocation.” Some 401(k) plans include resources, such as quizzes, to help you evaluate your appetite for risk.

Select Your Investments

Once you have an understanding of your risk tolerance, you can sort through the types of investments. The 401(k) provider will list the options in your plan. “Most of the time they will be sorted by key asset classes such as domestic stocks, large-cap, small-cap, alternatives and bonds,” says Alex Caswell, a wealth planner at RHS Financial in San Francisco.

You’ll want to keep the big picture in mind as you choose your investments. For instance, if your goal is to have a certain amount saved when you retire, you can start with that figure and work backward to see how much you want to put aside now and where to place the funds. Also consider if you have savings in different accounts besides the 401(k) plan.

“Investments within a 401(k) have to be screened for appropriateness before they are allowed in the plan, so many of the investments that are in the plan are from quality fund families and can help a person achieve their retirement savings goals,” says Kevin Chancellor, CEO of Black Lab Financial in Melbourne, Florida. “However, this can also present a double-edged sword in that the individual fund selection is usually limited compared to other savings vehicles such as the IRA.” A financial advisor can help you select the investments that are right for your situation.

Compare Investment Costs

A 401(k) plan has fees associated with maintaining the account and your investments. Some of these costs are fixed, while others are variable depending on your chosen investment options. “Fixed fees may include platform costs and recordkeeping costs, which remain constant no matter which funds you invest your money in,” Schubach says. “A variable cost in a 401(k) will be found in the various funds you can select for your contributions.”

To sort out the costs involved, look at the expense ratio of the funds in your 401(k) plan. Your employer can provide information about how much each fund in the 401(k) plan costs to own and the fees to expect. Some companies also provide information sessions to help you set up your 401(k) or access to a financial advisor. “Try your best to pick the fund with the lower fees as long as it is performing in line with the benchmark,” Schubach says.

Simplify With a Target-Date Fund

A target-date fund will allocate your assets for you, based on your estimated year of retirement. If your 401(k) plan includes this option, it can make the process easier. “The fund will be allocated more toward stocks the further you are from the date and will become more conservative and have a greater allocation to bonds when you get closer to retirement,” Caswell says.

If you’re looking for simplicity, this option might be a good fit, but it will depend on your overall goals. “Target-date funds can be a good investment choice for new investors who do not have access to an advisor and are not sure how to build a diversified portfolio,” Schubach says. “For more savvy investors, or those who work with a financial advisor, building a more customized portfolio using individual funds based on your objectives could be more beneficial.”

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