Tag Archives: 401k asset allocation

401k plan investments

How Most People Waste Their 401K Plan Investments

Avoid the critical flaw in 401K plan investments and put your 401K back on track

More than $21 trillion is invested in 401K plan investments across the United States with tens of millions of American workers relying on their plans for retirement. Besides the money invested in employer-sponsored 401K plans, you probably have investments in a regular investment account and individual retirement accounts.

While putting money away for your retirement is critical to meeting your financial goals, most people are wasting the investments in their 401K accounts and plan advisors know it and aren’t saying anything.

Why you’re investing wrong in your 401k

The problem is that your 401K plan investments are most likely completely segregated from the rest of your wealth and investment portfolio.

Think about how you set up your 401K plan at work. You probably met with a plan advisor, maybe even a couple of advisors from different approved fund providers. Hopefully you chose the 401K plan advisor with lower fees and sat down for a consultation. The advisor looked at your age and retirement goals and then suggested a few funds in which to regularly invest part of your paycheck.

…and that’s where it ended. You’ve been contributing to the same funds in your 401K plan for years and haven’t really thought much about your investment choices.

Besides pushing you into some of the funds with the highest commissions for the advisor, there’s one more critical fact that the advisor neglected to mention while setting up your plan contributions.

If you’re not building your fund contributions around your other assets and investments, you’re wasting your 401K plan.

Contributing to your 401K plan investments with no consideration to how it fits with your overall investments is likely over-allocating to some assets and missing out on the upside in others. Your plan advisor knows this but doesn’t really care as long as he can get you into those high-commission funds.

The way most advisors set up employee 401K plans is based on their age and a very fleeting look at the investor’s risk tolerance. Younger investors end up getting pushed into mostly stock funds while older investors fill their 401K plans with bonds. The plan might not be completely misguided by itself but misses the opportunity to diversify the investor’s total wealth and reach their investment goals with as little risk possible.

How to Get Your 401k Plan Investments Back on Track

401k plan investments Really taking advantage of the opportunity in your 401K plan means understanding how it fits with all your investments. This means first putting together a list of all your investments outside of your 401K plan.

First, note how much you have invested in each asset class. This includes stocks, bonds, real estate and alternative assets like private equity and hedge funds. Don’t forget to include your direct investments in real estate property. If you hold any exchange traded funds or mutual funds in bonds, include them in your fixed-income allocation even though the investment might trade like a stock investment. The same goes for real estate investment trusts (REITs) with real estate.

Once you’ve got your total investment in each asset class listed, go through each to note how much you have in the individual sectors (i.e. consumer staples, consumer discretionary, energy, financials, materials, technology, utilities and healthcare). This is an important step that many investors don’t realize could make a seemingly safe portfolio extremely risky. For example, even an all-bond portfolio may carry a lot of risk if it’s over-weighted in cyclical sectors like energy and technology. Conversely, a stock portfolio almost entirely in consumer staples and utility stocks might be much less risky than you imagine.

Once you know your overall allocation to the different asset classes and within the different sectors, you can start to see gaps in your retirement plan and where your 401K investments might fit. If the gaps are fairly small, i.e. you should be investing more in bonds and other real assets, then you can use your 401K contributions to round out your total wealth.

I’ve talked to more than a few investors that found out they were grossly missing their retirement goals because they were way over- or under-allocated in an asset class and didn’t know it until looking closer at their investments. When this happens, using your 401K investments may not be enough to close the gap and you might need to adjust the investments in your other portfolios.

Don’t forget an investment in real assets like gold and silver as part of your investment plan. Most 401K plan investments don’t offer much of a choice in these critical assets so you’ll need to buy them in your individual retirement account (IRA) or as part of your other investment account. If your 401K plan is the majority of your investment planning, you’re likely not holding enough of these inflation-protected assets.

401k asset investments

Where to Put Your 401k Money

Use these points to decide your 401k asset allocation and where to put your 401k money

The old rule for investing and asset allocation used to be to subtract your age from 100 for the percentage of your portfolio you should keep in stocks, putting the rest in bonds. The misguided advice has caused millions to miss their retirement goals and misallocate their 401k money.

Besides the fact that Americans are living longer, making the 100 rule obsolete, the rule is an oversimplification that misses out on some very important points.

How Much Do you Need and at What Risk?

A better start to retirement planning begins with an estimate of how much you will need in retirement. You don’t have to be accurate down to the penny but should try to estimate your living expenses to the nearest $50,000 or so. Take your current expenses, deducting those that you won’t have in retirement like education and retirement savings, and then add in new expenses for things like travel. The Department of Labor Consumer Expenditure survey can help you see how much people spend on average according to their age.

Any retirement calculator will show you the return needed on your investments to meet your future spending needs; given things like age, annual savings and current investments. Your next step is to do a reality check on this number.

If you need a return of more than 10% annually on your investments to meet your retirement goals, you may need to rethink your savings rate or your goals. Aiming for such a high annual rate will force you into riskier investments and may cause you to panic-sell when the markets tumble. A return of between 4% and 6% for a blended portfolio of different assets is a more realistic goal.

Your own tolerance for risk will also play a part in your 401k investing plan. There’s nothing wrong with being a conservative investor, preferring stability to the possibility of higher returns. The biggest mistake you could make is chasing returns to the point that market volatility makes you nervous and leads you to commit bad investing behaviors.

Best Investments for your 401k Money

401k asset investments The most ridiculous and overused cliché in the world has got to be, “Don’t put all your eggs in one basket.” Why wouldn’t you put all your eggs in one basket? Are you going to put one egg in a basket and make several trips?

Alas, the intent of the saying is still one of the best pieces of investing advice even if the analogy doesn’t quite work. You need to diversify your 401k investments across several different asset classes and within each asset class or risk putting your retirement in jeopardy.

Stocks are the naïve favorite of 401k plans, mostly because they get the most attention from the media and from advisors. Be wary of your 401k advisor and their recommendation for stock funds. These funds normally charge a higher management fee and the advisor may be getting a bigger commission to recommend them. Since you are more limited to your investment choices in most 401k plans and stock funds carry higher fees, it might be smarter to hold less stocks in your 401k compared to other assets. You can carry a larger weight to stocks in your self-directed IRA accounts or other investing accounts to balance out your portfolio while benefitting from the widest selection of investments.

Bonds and bond funds are also a popular 401k allocation choice but you might have more invested than you think. Advisors have been pushing target-date funds recently, mostly because they pay higher fees, and many of these carry large weightings in bonds. There is nothing wrong with holding a large percentage of your portfolio in bonds, it’s absolutely necessary for older investors, but make sure you know how much you have invested across all your bond- and target-date funds.

Precious Metals are an essential but too often neglected component of 401k and retirement investing. Investments in gold and silver have lost favor with investors since the frenzied prices of 2011 but still serve a critical importance to retirement plans. Precious metals provide one of the few real protections in a market dominated by financial assets. Unlike financial assets like stocks and bonds, precious metals are real assets that keep their value against inflation and will increase in value during periods of high market volatility. Beyond the fundamental need for safety, supply and demand are at turning points which may drive prices higher soon and make for very strong investment returns.

Even an allocation to riskier alternative investments like futures and private equity might have a place in your 401k plan. These investments may be higher risk by themselves but will still help to smooth the risk in an overall portfolio when combined with stocks, bonds and metals. You probably don’t want more than 5% or 10% of your 401k allocated to alternative investments but some allocation is important.

Will my 401k Investments Change as I get Older?

Probably the most important thing to remember about your 401k allocation is that it will change as you get older. That stock-heavy portfolio might be Ok for the new investor in their 20s but it will mean way too much risk for the 30- or 40-something investor.

There’s no rule to when you should shift your 401k allocations but most people revisit their strategy every ten years. This makes it easy to remember and avoids changing your allocation too often and paying too much in fees.

401k allocation investments

Don’t forget that your 401k allocation strategy should be as a part of your entire wealth strategy. It may be a separate account but your 401k money is still a part of your larger financial picture. If you have a large percentage of your regular investing account in risky assets, you might want to overweight your 401k investments to safer assets like bonds and precious metals. This will even out the risk in your overall wealth and prevent a market correction from wiping everything out.

Be sure to rollover those old 401k accounts from previous employers into individual retirement accounts for better flexibility and lower fees.