Choosing 401(k) investments is a two-step process. First, you decide on an asset allocation that’s appropriate for your timeframe and risk tolerance. Then you select the specific investments within each asset class to create a diversified portfolio.
To get a feel for putting a 401(k) portfolio together, take a look at these three hypothetical asset allocations. Each is designed to show a level of risk that may be appropriate at a particular stage of your career. The most aggressive assigns 80% to equities plus another 10% to balanced funds and just 10% to fixed income. That’s noticeably different from the most conservative, which allocates just 40% to equities, 20% to balanced funds, and 40% to fixed income.
Keep in mind that these allocations may not be right for your particular situation, and there are a variety of factors you may want to take into account as you decide among your choices. For example, you should consider the types of investments you may hold outside of your 401(k) when deciding on your 401(k) allocation. If you have a separate investment portfolio that is heavily invested in bonds, you may want to concentrate more of your 401(k) in stocks, or vice versa.
20
or more years to retirement
10
to 20 years to retirement
5
years or less to retirement
Large-company
stocks & funds
40%
35%
30%
Small-company
stocks & funds
30%
20%
10%
International
stocks & funds
10%
10%
—
Balanced
funds (stocks and bonds)
10%
20%
20%
Long-term
bonds& funds
10%
15%
30%
Money
market funds
—
—
10%
In contrast, there are significant similarities in the way these portfolios are diversified among various asset subclasses. None of them invests only in large companies or only in small ones. Most invest in international funds.
If your plan offers more than one plan in each subclass, the final step in creating your portfolio is choosing the particular funds that you determine are most appropriate. To do that, you’ll want to consider the investment objective of each fund, its risk profile (link to risk-to-return profile), and the fees associated with it.
History lessons
Also, you’ll want to look at the historical performance of the investment offerings in your 401(k) in relation to similar investments. If the large-cap stock fund that your 401(k) offers is a top performer in its class, but the small-cap fund delivers consistently disappointing returns, you may want to invest a higher percentage of your contributions in the large-cap fund, and invest in a small-cap fund of your choice in your separate investment portfolio.
