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Choosing the Best
Investments for Your 401(k)
By Ginita
Wall, CPA, CFP
 To
make choosing easier, begin by grouping the available funds.
- Stock funds include large-company
stocks (including ''growth and income'' funds),
small-company stocks (including ''aggressive growth'' funds)
and international stocks.
- Bond funds are categorized by length
of the bond -- such as short-term, intermediate or long-term
-- and by the kind of bond, such as government, corporate,
high-yield or international.
- Stable-value funds are sometimes
called GIC, guaranteed-income or money funds. (Of these
stable-value choices, IRA investors will generally have
access to money market funds.)
- Balanced or asset-allocation funds
consist of various mixes of these investments in a set
percentage.
Understand your time horizon
If you're years from retirement, investing most of your
money in stock funds makes sense. But if you plan to borrow from
your 401(k) plan soon, that portion should be in stable-value
funds, so you don't have to liquidate stocks or bonds that have
gone south in a sour market.
Understand your risk tolerance
Stocks are more volatile than bonds, and bonds are more
volatile than stable-value funds. Volatility is what we mean by
risk.
If you have 10 years or longer before
you retire, stock funds will reward you with higher returns even
though your plan value may dip at times, so you should invest at
least 80 percent of your plan in stock funds.
If you are less than 10 years away from
retirement, or if you are deathly afraid of losses, pare your
stock investments, but don't eliminate stocks entirely. A mix of
30 percent stocks and 70 percent bonds is actually less volatile
than 100 percent bonds. Most 401(k) participants should invest
at least 60 percent of their funds in stocks.
Diversify
Once you have decided the
percentages for stocks, bonds and stable-value funds, it's time
to pick the best funds.
Let's say you want 80 percent stocks and
20 percent bonds. Gauge the three-year performance of the funds
and pick one stock fund from each of the major categories: one
large cap (or S&P 500 index) fund, one small cap (or
aggressive-growth) fund and one international fund. Then pick an
intermediate bond fund and a high-yield bond fund. Allocate your
investments among the funds: 30 percent large cap, 30 percent
small cap, 20 percent international, 10 percent intermediate
bond and 10 percent high-yield bond. You are now fully
diversified with just five funds.
If you choose a balanced or
asset-allocation fund, most of the diversification is contained
in one fund.
Reallocate annually
If your large cap stocks now
comprise 40 percent of your 401(k) assets instead of 30 percent,
reduce your large cap contributions and beef up contributions to
an underweighted category.
Every investment has its season, and by
investing in categories that are trading for less, you will be
following the old adage ''Buy low, sell high.''
Summary Checklist
- Categorize your options
- Understand your time horizon
- Understand your risk tolerance
- Diversify
- Reallocate annually
At WIFE we welcome your comments. Please feel free to contact us.
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