With enough responsibilities in our present daily lives, it’s easy to forget about obligations we might have twenty, thirty years down the line. This can make it easy to overlook something like how your 401(k) is invested and allocated.
Most people likely put faith in the company their 401(k) is held with to invest their money in a modest, responsible way. Your 401(k) is an investment, after all, and probably one of the more important ones you will make in your lifetime. Here are some basic guidelines to follow to make sure you’re in a good place.
The Rule of 110
Financial advisors use the rule of 110 as a basic guideline for how much stock should be in a given portfolio. This is because more stock equals more risk. The formula is 110 – your age = the percentage of stocks you could hold in your portfolio.
Say you’re 35. Subtract 35 from 110 to see the optimum percentage: 110 – 35 = 75% equity holdings.
The majority of your portfolio can be in equities because you have about a 25-year investing period ahead of you. You can take more risk, and the longer holding period of riskier investments allows for higher possibilities of better returns.
Now, say that you’re 58: 110 – 58 = 52% equity holdings.
As you age, you should slowly start moving out of stocks and into safer investments like bonds and Treasuries. An important thing to note here is that even at age 64, the formula gives you 46% equity holdings.
This is a rough guideline of how a financial advisor would likely move a client out of a high percentage of equities as retirement approaches. However, the correct percentage is also heavily dependent on the market climate. For example, you would’ve been hard-pressed to find a financial advisor in 2009 strictly adhering to the rule of 110 for their older clients’ portfolios, given the volatility.
That said, a certain percentage of equities is necessary to keep providing you returns to both outpace inflation and maintain sustainable portfolio growth well into your retirement. The balance is a bit of a dance between conservatism and risk taking, but the general principle is to reduce risk exposure as you age.
Once you’ve determined a basic weighting of equities vs. bonds that you’re comfortable with owning relative to your age and goals, it’s important to diversify within that asset allocation.
Say you’ve decided to hold 60% equities and 40% bonds and/or cash. That allocation alone is considered diversification, but the 60% of equities still needs its own balance.
Diversifying within the riskier part of your portfolio is crucial, and it’s something financial advisors do for all of their portfolios. The Financial Industry Regulatory Authority states that “by including different assets classes in your portfolio, you increase the probability that some of your investments will provide satisfactory returns even if others are flat or losing value.”
Not all equities are created equal. Blue-chip stocks are relatively safe compared to penny stocks, which are notoriously volatile. The weighting of how many safe vs. volatile assets you own within your equities portfolio is entirely up to you. For the most part, though, 401(k)s tend not to include the riskiest investments as options. That said, you can still expose yourself to significant risk with the options provided to you.
The basic tenant to remember is this: blue-chip companies are larger and safer and can provide steadier returns than newer, smaller companies. Some examples are Lowe’s, Johnson & Johnson, Disney and Procter & Gamble.
It is a good idea to start off with choosing blue chip stocks you like, and then add riskier, small- to mid-cap companies from there.
Call Your 401(k) Representative
Whether your 401(k) is held with Fidelity, Vanguard, T. Rowe Price or another firm, your broker is obligated to help you. It might seem like a hassle, but they are responsible for talking you through any misgivings you might have about a particular fund or other investment you are thinking of making. Most of the time, representatives are more than happy to help, but beware — these representatives often will take the opportunity to try and sell you on other products or investments you might not be interested in.
Most of these providers are available to speak on weekends.
Get All Your 401(k)s in One Place
Getting a representative from your plan provider on the phone can also help you roll over any old plans you have from previous employers. These plan providers are incentivized to get you to roll over your old 401(k)s into their company, and the process has become commonplace. Rolling over all your assets to one investment firm gives you a holistic understanding of where your money is, and where it should be going.
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