Finding the Right 401k Allocation

The right 401k allocation is going to be a matter of age and risk tolerance as well as the composition of your other retirement assets.


401k allocation asset allocation on a ticker

According to the Investment Company Institute, the average 401k plan offers 13 mutual funds, with more than half of the assets invested in U.S. stock funds and target-date funds. Some 401ks offer ETFs too. I love 401ks, so don’t take this in the wrong light. But in my opinion, there are two issues with 401ks—they don’t offer enough investment choices and employers skimp when it comes to educating employees on those choices and 401k allocation and investment strategies in general.

There’s not much you can do about the first issue, other than to make recommendations to your employer to expand your plan. But I was so fed up with the second problem that in the last company in which I was an employee, I developed a short course for the other employees to thoroughly explain 401k allocation and our options. You may also want to suggest to your employer that they do something similar.

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In the meantime, let me give you some ideas of what your choices and strategies may be. Since I don’t know the details of your plans, I’m just going to give you some general information and some common scenarios.

First of all, you need to understand how much risk you are willing to take with your investments. Most investors will fit into one risk category (although a blended approach can work as well).

3 Broad Categories of 401k Allocation

Conservative: As a conservative investor, you are less willing to accept market swings and significant changes in the value of your portfolio in the short- or long-term. Capital preservation is your primary goal, and you may plan on using the principal from your investments in the near term, preferably as a steady income stream. The average level of return you expect to see is 5%-10%, annually.

Moderate: As a moderate investor, you seek longer-term investment gains. You are comfortable with some swings in your portfolio’s performance, but generally seek to invest in more conservative stocks that build wealth over a substantial period of time. The average level of return you expect to see is 10%-25% annually.

Aggressive: As an aggressive investor, you primarily seek capital appreciation and are open to more risk. Swings in the market, whether short term or long term, do not impact your investment decisions and you have confidence that volatility is necessary to achieve the high return-on-investment you are looking for. You typically expect a 25%+ return annually, though you do not need your principal investment immediately.

In general, the younger you are, the more aggressive you can afford to be with your 401k allocation, as you have a long time span before retirement. But that also depends on your personal situation—health, family, salary, etc. A few years ago, I devised a simple survey to help you determine your risk profile. You can find it here.

Your 401k plan will generally offer you a variety of risk scenarios. They may be called conservative, moderate, and aggressive. Or they may be labeled Equities, Income, or Balanced. In that case, Equities would be the most aggressive 401k allocation. But understand that different funds—even if they are mostly comprised of stocks (equities) may have varied risk profiles. For example, a small-cap only equity fund will be much more volatile (riskier) than a large, blue-chip equity fund. An income fund will most likely be made up of dividend-paying companies and/or bond funds. And a balanced fund should have some equities and income investments in it.

As you can see, it would behoove you to know the exact investments that comprise each fund. That way, you can determine the risk level and appropriate 401k allocation for yourself.

Do you find the 401k options offered by your employer to be robust and diversified?

This post was previously featured in Financial Freedom Magazine. To read more about 401ks, investing for retirement, and the best financial advice, subscribe today!

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