How to invest in your 401(k)
Investing can be overwhelming if you aren’t a financial advisor or investment savvy. Investing in your 401(k) can be a great way to jump-start your retirement plan and begin saving. It can also be a very overwhelming experience when you have to choose which positions and what percentages to choose in each.
Categorize your positions
While you may have 15 or 20 choices in your 401(k), chances are you will only need to make a few actual decisions when it comes to picking your positions. This is because when you are building your asset allocation model, you’ll most likely choose large, mid and small-cap positions. In each of these style boxes or categories, you’ll probably only have a few options. If you do have multiple choices in one style box, it’s most likely because the positions have been separated further into growth and value. I’ve attached a visual below to make it a little easier to follow. As you can see you have growth, value and blend in the middle. Blended funds are a mixture of growth and value, hence the name.
Choose your percentages
Once you have figured out which positions go in which style box, now it’s time to choose how much you’ll allocate into each investment. You may have been provided model portfolios by our 401(k) provider, which can be used as a starting point. The more equities vs. bonds in your portfolio the more volatility you can expect in your portfolio. As you near retirement, it’s possible to find a target mix of 60% equities and 40% bonds meeting your objectives. It depends on your situation and risk tolerance but this can be a starting point to consider.
It may be tempting to only choose those investments with the highest returns but buyers beware! Past performance is not an indication of future returns. While small cap stocks have outperformed large cap stocks historically over various periods, it may be wise to diversify. Diversification offers two main points; reduced risk and an increase in predictability. Choosing which style box will outperform in any given year may prove futile. However, a diversified portfolio has been historically more consistent that any one particular style.
Rebalancing your portfolio annually will reduce the emotional aspects that often come with investing. It will also create a systematic management of your portfolio. In effect, rebalancing is going to sell high and buy low.
These are only a few strategies that may help you invest in your 401(k). It’s important to do your homework while implementing these strategies.