If you have elected to participate in your employer’s 401(k), you must choose among the variety of investments, such as mutual funds, target date funds, stable value funds, and sometimes company stock, that the plan offers. You also have to decide how to divide your contributions, on a percentage basis, among the ones you select. That’s the process called asset allocation. To make effective choices, you need to understand how each category of investment puts your money to work to provide a return and the potential investment risks you face.
For example, if your plan offers only mutual funds, you might select three stock funds and a bond fund and divide your contribution evenly among them. Or you might put 30% of the total in each stock fund and 10% in the bond fund. On the other hand, if the plan offers target date funds linked to specific retirement years, such as 2015, 2025, or 2040, you typically put your total contribution into the fund whose date is closest to the date you expect to retire. The allocation of a target date fund is gradually adjusted to be more conservative as the date in its name draws closer.
If you’ve been automatically enrolled in your plan, your employer will deposit your contribution into a specific fund, such as a target date fund or other qualified default investment alternative (QDIA) approved by the US Department of Labor. You have the right to switch that allocation and direct your money into other plan choices.
Company stock in your 401(k)
Your allocation decision may be more difficult if company stock is one of your choices. The advantage of putting money into the company stock is that your account balance will grow if the stock price rises. But the risk is that your employment income and your retirement income are both dependent on the same source. If the company falters and the stock price drops, your financial security could suffer. If your employer matches contributions with company stock, or offers a larger match if you put your money into the stock, your situation may be even more complicated. Anytime your 401(k) account is too heavily concentrated in one investment, your allocation is out of balance. That increases your risk of major losses. One solution may be to set a percentage of your account value that you’re comfortable having in company stock — say 10% or 15% — and not allow it to grow larger. Another may be to build a separate, diversified retirement account, such as an IRA, to offset your narrowly focused 401(k).
