One of the most important decisions you have to make in your 401(k) plan is asset allocation — that is, how much you put in stocks, bonds, and cash. Asset allocation is the strategy of dividing your investments across various asset classes in order to reduce risk through diversification. Here are two simple approaches to get you started.
What's Everyone Else Doing?
One method to start is to look at the leading pension funds in the US and see how their participants divide up their investments. Based several industry studies from 2016, the average asset mix is about 56% in equities, 41% in bonds, and 3% in cash. Using these numbers as a guide, you can probably feel comfortable if your allocation is positioned plus or minus 5% around these national averages.
Base It On Your Age
A second approach is to use a simple formula that is “100 minus your age” equals to your equity exposure. The idea here is that the younger you are, the longer you have to invest so you can be more willing to take a more risk in exchange for more growth. Older participants who do not have the luxury of time to recover from downmarkets may have more desire for income and stability and therefore allocate 60% in bonds and 40% in stocks.
What Can You Stomach?
Besides factoring your age into your asset allocation decision, you have to determine what kind of investor you are. Are you conservative, moderate, or aggressive? This determination may actually be more important than many realize because financial related stress can impact your physical or mental health. Many people hire a financial advisor for this very reason, to help them determine their tolerance for risk and to outsource the asset allocation decision making so they do not need to look at it on a daily basis.
Very basic guidelines:
- 70/30 mix in favor of equities if you are more aggressive
- 50/50 if you are moderate
- 40/60 if you are conservative
How is your 401(k) allocated between stocks, bonds, and cash? How often do you review your allocation?