There are often many important questions around how to invest money in your 401(k). For most of us, what we are able to accumulate in our 401(k) during our working lives is going to be a critical component to our retirement. Because of this, it is very important to remain properly invested. Since every retirement plan is different, and everyone has different personalities, ages and risk tolerances, there is not a one-size fits-all answer, but I have for you some general guidance that should help.
If you are someone who does not have any interest in learning more about the differences of each fund, and want to just set-it-and-forget-it, a target date fund could be the best option for you. Target date funds are investment options that have a year at the end of the fund name (like 2020, or 2055). This date should roughly coincide with the approximate year you plan to retire. As this date gets closer and closer, the fund manager will reduce the risk of the fund. This de-risking is done to protect you from anything drastic happening to your money as your retirement date nears. Target date funds can be found in most retirement plans and can really be useful as a set-it-and-forget-it strategy.
A downside to using target date funds is that they can be costly, and every cost you incur when investing comes off your potential return. To avoid the high costs, you can use some of the less expensive fund options inside your 401(k), but this may require more research. Look for index funds within your available options, as these generally will be the least expensive. Combining a few index funds representing different markets, like the S&P 500, MSCI ex-US, Barclays Agg Bond ….etc.will create a diversified, low cost portfolio.
For those who want to build out their own portfolio, you also need to decide what percentage of your money should be directed to each fund. This is something that changes with risk tolerance. The more risk you want to take, the more money you want to allocate to US, International and Emerging equity markets. Between the US, International and Emerging equity markets, most people usually focus mainly on US positions, with a lesser percentage of assets in international developed markets, and an even smaller percentage in emerging markets. If you want to build your own portfolio, you also need to remember to re-balance it at least yearly. This insures allocation does not drift too far from its target.
The last piece of your constructed portfolio needs to be a bond index. A bond index is used to reduce market risk and therefore act as a governor, smoothing out the performance of your portfolio. Over time, as you grow closer to retirement, this piece of your portfolio needs to increase and become a higher and higher percentage of your portfolio. At retirement age this portion should be around 40% to 60% of your portfolio, depending on your risk tolerance.
What do you think? Is it better to use the target date funds, or is building a customized allocation the better way to go? Reply with your answer, I’m interested to know your thoughts! Also, keep in mind, I can make myself available for a brief call if you want to discuss your specific situation and how our firm can help. Just click here to schedule a time: calendly.com/austin-smith-1