Use Target Date Funds For Your 401k Money
You’ll know your 401k offers a target date fund when you see a calendar year in the name of the fund, such as T. Rowe Price Retirement 2020 Fund. Target-date funds simplify long-term investing. Choose the year you wish to retire, then pick the fund with the date closest to your target. So, for example, if you're 55, and plan to retire in ten years, choose a fund with 2020 in its name.
These funds spread your 401k money across large company stocks, small-company stocks, bonds and other assets classes, such as emerging-markets stocks and real estate stocks.
As you near the target date, the fund progressively becomes more conservative, owning less stocks and more bonds. The goal is to reduce the risk you are taking as you near the date where you will need to use your 401k money.
Put Your 401k Money In Balanced Funds
A balanced fund spreads money out across both stocks and bonds, usually in a proportion of about 60% stocks, 40% bonds. In times when the stock market is quickly rising, expect that a balanced fund will not rise as quickly. In times where the stock market is falling, expect that a balanced fund will not fall as far.
If you don’t know when you might retire, and you want a solid approach that is not too conservative and not too aggressive, choosing a fund that has “balanced” in its name will be a good choice.
Model Portfolios For 401k Money Are Great
Many 401k providers offer model portfolios. The portfolios have names such as Level I, II, III, or Conservative, Moderate, Moderately Aggressive. These portfolios are crafted by skilled investment advisors so that each model portfolio has the right mix of investments for its stated level of risk.
Most investors are best served by putting their 401k money in one of these models, rather than trying to pick and choose among available funds. Many of my friends send me their 401k statements and ask me what they should do. Whenever I see model portfolios available, I recommend they use them. It results in a better, more balanced, more disciplined approach than I could ever design for them.
Spread 401k Money Equally Across Available Options
Today, most 401k plans are required to offer some version of the choices described above. If they don’t, spread your money out equally across all available choices; this will often result in a relatively balanced portfolio.
For example, if your 401k offers ten choices, put 10% of your money in each.
Or pick one fund from each category; such as one fund from large cap, one from small cap, one from bonds, one from international, and one that is a money market or stable value fund. In this scenario you’d put 20%, or 1/5th of your 401k money in each fund.