How to Invest the Funds in Your 401(k)

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Knowing how to effectively allocate the funds within your company 401(k) plan doesn't have to be an ordeal. Following these simple steps can help you to construct a successful retirement plan portfolio.

Things You'll Need

  • All of your company 401(k) plan mutual fund information
  • The type of investments that you choose for your 401(k) plan will depend largely upon your time horizon to retirement and your risk tolerance. If your retirement is more than 10 years away, then the majority of your portfolio should be invested in common stocks, either individually or inside a mutual fund.

  • If your plan allows you to buy company stock, this can be a good idea-as long as your overall portfolio remains adequately diversified. A good rule of thumb is to invest no more than 10 percent of your plan assets in company stock. Employees at Enron and Worldcom who ignored this rule eventually paid the price.

  • Once the company stock issue is resolved, then the task of choosing which mutual funds to invest in within the plan must be undertaken. Long-term investors should probably ignore the cash, income and bond funds within the plan, unless there is an agressive junk bond or high-yield fund available to choose from. Historically, the stock market has always been higher at any given time than it was 10 years before, without exception. Therefore, investors with a time frame that equals or exceeds 10 years will most likely get a better return on their money from stocks than from any other asset class.

  • Finally, once you have narrowed down the investment choices to all eligible stock and agressive bond funds (real estate and natural resource funds can be included as well), the process of winnowing down to two to five funds begins. Evaluation of the fund choices should consider historical performance (probably the most important factor), volatility, longevity and fees and expenses.

  • An effective stock fund allocation should ideally diversify you between large and small cap stocks and several different sectors of the economy, such as healthcare, technology and energy. While there are no hard and fast rules for this, if you have less than $10,000 in your plan, then one to two mutual funds will probably provide sufficient diversification. Portfolios over $100,000 can be invested in as many as five funds, depending upon one's asset allocation strategy. Plan balances that fall between these two levels can be adequately diversified with somewhere from two to five funds, depending upon the level of sophistication of the investor.

  • If you are less than ten years from retirement, then it's time to start reallocating some of your plan assets into more income-oriented categories, such as bonds and cash. If you have only five years to go before you retire, then a 50/50 mix of stock and bond investments is probably wise, because you still need some growth within your portfolio.

  • Once you retire, you can either keep your plan where it is or roll it over to an IRA or Roth IRA, which is what most people do. You can also either keep your current investment allocation intact or modify it at this point. Many retirees enlist the aid of a financial advisor to help them do this properly. But even after retirement, at least a small portion of your portfolio should ideally be allocated to stocks as a hedge against inflation.

Tips & Warnings

  • This article is intended as a general primer for 401(k) plan allocation. It is not intended as specific investment advice. Each employee must consider his or her own investment objectives and risk tolerance when choosing among the funds that are available.
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