Decisions, Decisions
Mutual funds are an attractive funding option, and it's common for plans to have a range of six to twelve funds from which to choose.
Obviously, it's important to choose your 401(k) investments wisely. Generally, this can be achieved by carefully analyzing your options and your investment personality before you make any final investment choices.
The vital issues that come into play generally revolve around three basic factors:
1. Your age and the number of years before you will need to make use of the funds-also known as your “time horizon.”
2. Your ability to accept investment risk-commonly referred to as your “risk tolerance.”
3. Inflation, which has an eroding effect on all investments over time.
Combining these three factors with the concept of asset allocation can be extremely helpful, as well. This method divides investment funds into specific categories — generally, equities (stocks or stock mutual funds) and fixed income securities (bonds or bond mutual funds).
For instance, if retirement is close by, say 5 years away or less, a more conservative approach should be considered. Under these conditions, up to 75 percent of your investment portfolio may be targeted to fixed return investments. On the other hand, suppose retirement is 5-10 years away. In this case, you may wish to pursue moderate growth and moderate preservation of capital. A balanced approach would be perhaps 50 percent going to fixed income securities and 50 percent going to equities. If you have more than 10 years until retirement, you might consider choosing more growth-oriented investments and place up to 75 percent of your portfolio in equities and only 25 percent in bonds. The above percentages may be modified to take into consideration your overall investment goals and your tolerance for risk.
Don't Put All Your Eggs in One Basket
Once you've decided on your asset allocation mix (based on your time horizon), it's time to diversify your investments within each category. Because your 401(k) offers several investment options, you can pick and choose which option(s) best fits your tolerance for risk.
For example, suppose your retirement is 20 years away and you decide to allocate 75 percent of your contributions to equity investments. As you review the available fund choices, you notice there are six different stock funds from which to choose. Each stock fund has different objectives and varying levels of risk associated with it. By selecting several funds that match your tolerance for risk, rather than just one, you can help minimize your overall risk from loss in the event that one fund under performs.
Remember, the Choice is Yours
The preferred path for any 401(k) investment plan is for you to objectively study the investments offered by your employer. Only in this way can you evaluate all criteria and make meaningful, long-term decisions.
(Mr. Wallace holds NASD Series 7 (General Securities) licenses and Group I and IV Life-Health Insurance Licenses. He is a Registered Representative of MML Investors Securities, Inc., an Investment Advisor Representative of Spectrum Strategies, LLC, and an Investment Advisor Representative and Registered Representative of MML Investors Services, Inc. You may reach him @ ejwallace@finsvcs.com or visit his website at spectrumstrategiesllc.com.)
