Retirement plan decisions made easy
Lesson 3: Investments “Cook Book” Approach
This lesson offers my conclusions about how to invest your 401k; it’s for people who simply want answers. The next lesson explains how I reached these answers. Feel free to read just one of these two chapters. With your 401k, you’ll have some investment choices. So I’m going to give you some basics to help you make your decisions. Your portfolio—what we call all of your investments, across all the different accounts in which own them—can hold a variety of assets. It could hold individual stocks (shares of company ownership), bonds (debt of a company or government), mutual funds (boxes that can hold stocks or bonds), and money market mutual funds (mutual funds that own very short-term debts).
Each of these investments has varying levels of risk, and generally speaking, the higher the risk you take, the greater your return will be. Risk means the possibility that some of the investments will go sour, and you’ll be left with less than what you expected. Risk is bad, but high returns are good. Unfortunately, you can’t get one without the other, and you need to accept some risk if you don’t want to be stuck with very low returns.
Drill Down: Find Your Risk Tolerance
To make the best allocation decisions for your investments, you need to take into account your tolerance for risk—your willingness to accept those stomach-churning busts—and then divide your portfolio into stocks and bonds appropriately. A common allocation is 60 percent stocks, 40 percent bonds. Adjust this to reflect your own attitude toward risk and your own age. The younger your are, and the more you can accept risk, the more you should invest in stocks.
Drill Down: Picking Your Investments
Your bond money should go toward a short-term bond fund or a short-intermediate bond fund. If your only bond option is a long-term bond, then split your bond money half and half between a money market mutual fund and the long-term bond fund. Your stock allocation should look like one of the variations below. Don’t worry if you can’t make it exact; just get in the ballpark.
Basic Stock Market Allocation (if you own a home)
- 40% U.S.
- 34% large cap (S&P 500)
- 6% small cap
- 60% International
- 48% developed countries
- 12% emerging countries
Stock Market Allocation with Real Estate (if you don’t own a home)
- 28% U.S.
- 24% large cap (S&P 500)
- 4% small cap
- 42% International
- 34% developed countries
- 8% emerging countries
- 30% Real Estate
After you’ve divided your money into these allocations and some times passes, your allocations will be wrong because some of your mutual funds will have risen in value while others will have diminished. You’ll need to “rebalance” by pulling money out of the mutual funds that are above your desired allocation and putting it into funds that are lower than your targets. You could do this every month if you wanted to, but once a year is sufficient.
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Lesson 1: What the Heck is a 401k, and What’s So Great About It?
Lesson 2: Contributions to Your 401k
» Lesson 3: Investments “Cook Book” Approach
Lesson 4: Investments: How Investments Work
Lesson 5: Loans and Hardship Withdrawals from Your 401k
Lesson 9: Your 401k, Your Other Assets, and Your Life
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