If your 401(k) is the only investment account you have, you must build a well-diversified mix of assets using the funds offered.
Here are tips to get started:
- Make a plan: Many 401(k) plans offer participants an online tool that can help retirement savers build a portfolio on their own.
The tool asks a few questions about risk tolerance, among other things, and then slots you into a portfolio, with guidance on the mix of stocks, bonds and cash.
Otherwise, use a target-date-fund glide path — the changing mix among cash, stocks and bonds along the 70-year life of the fund — as a guide.
“It’s a reasonable way to start,” said Rob Williams, vice president of financial planning at Schwab Center for Financial Research. Use them as a model — adjusting where necessary — to set up your investment plan.
- Keep it simple: The typical 401(k) plan offers 27 funds.
If the number of choices in your plan is overwhelming, start with low-cost index funds.
Whether you’re choosing passive or actively managed funds, or a mix of both, focus on core stock funds and core bond funds that invest in a broad swath of each market to build your portfolio.
Stay away from funds such as a technology sector fund until after you have put together a well-diversified portfolio. “Those are niche and supporting funds, but they’re not always labeled that way,” Williams said.
- Don’t put all your eggs in one basket: Be sure to include funds that invest in large, midsize and small companies, and consider funds with different investment approaches, such as growth and value.
Otherwise, you’ll take on more risk than you realize. One quick fix is to buy shares in an index fund that invests in an entire market, said Maria Bruno, head of U.S. wealth planning research at Vanguard.
- Time horizon trumps risk tolerance: Risk tolerance and time horizon are important factors in asset allocation.
But “time horizon trumps risk tolerance,” Williams said.
A 50-year-old investor with a high tolerance for risk may want to be 100% in stocks. But at that age, she should be scaling back on stock holdings for bonds and cash.
The flip side is also true. Young, risk-averse investors with decades to invest may hold too much in cash.
“There’s an opportunity cost to not being in the stock market,” Bruno said, and that’s the risk of not having an ample nest egg when you retire.
- If you’re unsure, go with a target-date fund: Some critics chide target-date funds as one-size-fits-all solutions that ultimately fit few.
But “age is the dominant factor” in any asset allocation plan, said Toni Brown, head of retirement strategy at Capital Group.
And target-date funds that make all the investment decisions for you offer investors access to professionally managed portfolios.