How to Allocate 401(k) Stocks
Determining the proper allocation for your 401(k) account is an important step in establishing a plan to prepare you for retirement. There is a personal balance you must strike between minimizing risks and chasing returns. Ideally, you will identify a plan that is low-risk but still sets you up for a modest return. Once you've set your personalized plan, the most important part is to stick to it and stay out of the game of adjusting your allocations based on fear, market movement or the opinions of others. Your allocation plan should make you confident in your investment strategy, regardless of recent market events.
- Difficulty:
- Moderate
Instructions
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1
Determine your appropriate allocation percentage to stocks by subtracting your age from 100. Adjust this number upward if you are more tolerable to large swings in your 401(k) balance or downward if you would like a more steady balance. This is your Total Stock Allocation; write down this percentage.
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2
Determine your appropriate allocation percentage to bonds by subtracting your Total Stock Allocation from 100. This is your Total Bond Allocation; write down this percentage.
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3
Calculate 80% of Total Stock Allocation to identify how much you should invest in U.S. domestic stock. Assign the remaining 20% of your Total Stock Allocation to international stock to diversify your holdings. Write down these percentages.
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4
Split your Total Bond Allocation in half and assign equal parts to nominal bonds and inflation-protected securities. Write down these percentages.
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5
Review the list of funds offered by your 401(k), matching fund names to the classes you have identified in your allocation plan: domestic stock, international stock, nominal bonds, and inflation-protected securities. Pick only one fund per class, ideally selecting the one with the lowest fees, identified by a low expense ratio, and the broadest diversification.
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6
Revisit your allocation plan every 10 years and re-allocate your 401(k) accordingly by exchanging between funds. Due to the tax-sheltered nature of a 401(k), such re-allocations generally do not create tax liabilities.
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Tips & Warnings
The domestic stock funds that generally will offer you the greatest diversification with the lowest fees are those that track broad market indexes such as the Russell 2000 or the S&P 500. These funds sometimes have names like "Total US Stock Market." Nominal bond funds invest in government and private corporate notes in the United States and often have names like "Total US Bond Market." Inflation-protected securities funds invest in Treasury Inflation Protected Securities (TIPS), which are indexed to inflation. Not all 401(k)'s will offer inflation-protected securities funds, in which case you may invest your entire Total Bond Allocation in nominal bonds.
Investments in stock and bond mutual funds may lose value. You should only invest 401(k) money using your allocation plan if you can tolerate a loss of value. You may reduce the potential of your investments losing value by investing some or all of your 401(k) deposits in a money market fund or certificate of deposit. As you get closer to retirement age, you should limit your exposure to stocks.
