Money Magazine is presenting five tips for building a great 401(k) account. Their first suggestion was to save early and save often by diverting as much as possible directly from your salary to your retirement account. Here’s the next tip.
What you must do, though, is choose a suitable combination of stock funds, bond funds and other investments. The idea is to create a blend of assets that’s aggressive enough to improve your odds of earning the returns you need, but not so risky that you’ll panic during market downturns and bail out.
The Money article talks about allocation between investment types: stock funds, bond funds, and other investments, without much discussion of various types of each. The authors suggest funds that target a retirement date. That’s not always the best solution, as the fees for “funds of funds” multiply behind the scenes.
First, determine how much risk you’re willing to accept. You could accept the level of risk provided for you by “target” funds, but that’s removing a level of responsibility from the investor. If you want your money to last even in cool markets, take on as much risk as you can handle without making rash decisions if your portfolio decreases.
CNN has an asset allocator tool that can help you determine your ideal portfolio. I’m not happy with the results, however. With my options, a 10+ year horizon, a high tolerance to risk, and a positive attitude about bear markets, it was suggested I invest 20% in bonds, 20% in foreign stocks, 20% in small-cap stocks, and 40% in large-cap stocks. I’d like to consider myself “still young” and investing almost all of my portfolio in stock funds seems more likely to provide me a return higher than inflation.
(Don’t believe the tame 3% inflation numbers people toss around. It’s not widely known that the formula to calculate inflation has changed.)