401k Investment Portfolio Strategy

The 401k is a very high powered section of the tax code that allows investors to make very intelligent investments with their money, in the most tax-advantaged ways possible. However, that doesn’t mean that people use them so wisely, and in many cases it just so happens that investors don’t make full use of their 401ks in the first place.

Making the most of a 401k
A 401k is an excellent retirement account because it is tax-advantaged, and also because it is often matched. That is, employers’ routinely match contributions made by employees in their own account.

The match is usually stated as a percentage against percentage of income. A 50% match on 3% of income, for example, is an agreement by your employer to match your investments 50 cents on the dollar up to 3% of your total salary.

Thus, if one were to earn $100,000 per year, he or she could invest $3,000 and receive the maximum employer match of $1,500. So, with only a $3,000 investment, the employee has saved some $4,500 for retirement! Believe it or not, many investors leave this money on the table, instead choosing not to save but to spend. As a result, investors across the United States miss out on many tens of billions of dollars in literally free money!

401k and Loss Strategy
One of the most important elements of a 401k is that it is protected against bankruptcy up to $1 million. Few consider this to be a benefit, though, since very few people plan for bankruptcy. However, in a world where many workers go from job to job over the course of their career, plenty of people go many months where they are unemployed. Without proper savings, and no real income, bankruptcy is inevitable.

But that only further strengthens the case of making the maximum contribution to a 401k. At $16,500 per year, the current legal annual contribution maximum allows most anyone to save enough money that they need not think about running out! Plus, since assets are sheltered up to $1 million, an investor with $1 million in a 401k, $5,000 in cash, and $20,000 in other assets (excluding a home) would stand to lose only $25,000 should he or she file for bankruptcy. Even after bankruptcy, the investor would still be a millionaire! Unbelievable!

Asset Allocation
How you divide your assets is secondary to whether or not you’re saving enough for retirement in the first place. Asset allocation strategy tells us that investors should encounter the most risk in their retirement portfolios when they can most afford to take it on—when they are younger. As they age, investors should revamp their 401k strategy so that their investments are segmented mostly toward fixed-income investments. The lower risk profile allows future retirees to have some reasonable expectations about their retirement date without concerning themselves only on the rapidly changing market conditions in the stock market.

Automatic Allocation Strategy
One emerging trend in the retirement planning space is the move toward automated allocation strategies. That is, the investor is responsible only for contributing cash to their retirement plan, and active fund managers distribute the funds as they see best.

Mutual funds of this type are sold as “target-date funds.” While target-date funds are considered to be on the higher-end of the fee spectrum, the benefit here is that investors need to know very little about investing at all. Instead, investors pick a fund with a reasonable retirement date, and as they age, the fund holdings are automatically adjusted toward reaching that goal. Thus, a 2015 fund, for example, is invested in bonds at a far greater ratio than that of a 2070 fund.

Comments are closed.