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How to Select Funds in Your 401(k) Plan

By Stuart Robertson

Many employees are new to investing or just have never had time to truly get educated on investing. So, while you may be excited about saving in a 401(k) plan, it can be tough to know what investments in your 401(k) to select that fits you and your goals.

We wish investing was super simple, but there is some knowledge that can help you do what’s right for you. If you don’t have the time or prefer your investments to be managed professionally, you can choose a model portfolio which best fits your time to retirement and “risk tolerance”. Generally, more aggressive model portfolios will be more volatile but can provide more gains over time than less volatile, more conservative model portfolios. Picking a model portfolio can be a smart way to go, and something to consider whether you are new to investing or a sophisticated investor. FYI, some providers may offer target date funds which make it simpler to select an investment but doesn’t make it simple to understand the risk you are taking.

Before You Pick Funds in Your 401(k) – Here’s What You Need to Know
First, work to contribute an amount that will be meaningful come retirement. Saving 10%-15% of your earning over a career is what most believe will get you to a comfortable nest egg at retirement, but don’t feel like you need to start here – just get started with 5%-7% or whatever works with your budget.
Next, it’s good to understand items like asset allocation and diversification of asset classes as they all play a part in how big your nest egg will be. But you might ask – what the heck are these terms? Here are some definitions to help:

  • Asset allocation is the amount you put into categories such as stocks, bonds and/or cash (asset classes).

    • Stocks: When you buy stock, you're purchasing a tiny bit of ownership in a publicly traded company (e.g. Amazon, Boeing…). The stock is traded on an exchange or electronic marketplace and has a trading price (value). Stock values go up and down. Generally, the better the company performs, the more your share of stock is worth. If the company doesn't do well, your stock may be worth less.
    • Bonds: When you invest in bonds, you are loaning money to a company or government. In return, bonds pay a periodic interest payment or a lump sum at maturity. Bonds are typically safer investments than stocks but carry a lower expected return for their safety. When bond prices rise, their interest payment lowers and vice versa.
    • Cash: Think a bank savings account or a money market. Cash equivalents are investments securities that are meant for short-term investing. They have high credit quality and are highly liquid. These securities have a low-risk, low-return profile and include U.S. government Treasury bills, bank certificates of deposit, bankers' acceptances, corporate commercial paper, and other money market instruments
  • Diversification is the process of balancing these asset classes (how much you hold in stocks, bonds, and cash), so they may offset one another amid ever-changing market conditions.

When you diversify your investments among basic asset classes you may lower your investment risk and help increase the chances of meeting your retirement goals.

Got it, But What Should My Asset Allocation Be?
So how much is best for you to put in stocks versus bonds. This comes down to how long until you will retire (time horizon), and how well you sleep at night when markets take a big dip (risk tolerance). In general, you can use your age as a proxy for how much to keep in bonds (the rest to stocks). So, if you are 30 years of age, you’d have 30% in bond funds and 70% in stock funds. Just know that if you don’t care about big market ups and downs, having more in stocks is the way to go. If market dips freak you out, hold less in stocks. Also, with people living 30+ years in retirement, a 70-year-old may want to hold more in stocks than the rule of thumb of 30% (maybe 40% or even 50% to stocks) if they are comfortable with this.

Our online risk questionnaire will give you a score and you can line-up with one of our model portfolios to either select it or use the model allocations to help you determine how you want to adjust with a portfolio you create on your own.

Okay, I Know My Desired Asset Allocation, but Which Funds to Choose?
For stocks, most people will want to consider having a big chunk in Large Cap stock funds and a smaller chunk in mid-cap, small-cap, international and/or emerging markets. In Bonds, intermediate, inflation-protected, and short-term could make sense. Now figuring this out to select your funds might sound hard and intimidating.

While you do need to think about what’s right for you, let’s look at ShareBuilder 401k’s Balanced Portfolio in Q2 2021 to see what these investment experts are doing. This portfolio is a 50% stock fund, and 50% bond fund asset allocation as follows:

Stock Funds Allocation
Large Cap Value – Vanguard’s VTV 18%
International – Vanguard’s VEA 10%
Large Cap Growth – Vanguard’s VUG 10%
Mid-Cap – Vanguard’s VO 6%
Small Cap – Schwab's SCHA 4%
Emerging Markets – Vanguard's VWO 2%

In stocks, you can see the pros are putting 28% in Large Cap options weighted more to Value (dividend paying stocks) than Growth. A balanced model like this is looking to emphasize income over growth and a “medium” volatility. So more volatile options like Mid-Cap, Emerging, Small-Cap, Emerging Markets are much smaller in the allocation than the Large Cap Value. (FYI, an aggressive model portfolio would up the overall allocation in stocks to 90%- 100% and have more in Growth than Value).

Bond Funds Allocation
Intermediate Bonds – Vanguard’s BND 39%
Short-term Treasuries – Schwab’s SCHO 6%
Inflation-Protected – Vanguard’s VTIP 5%

In Bonds, again, given the objective of a balanced model portfolio, the intermediate bonds take the majority of the bond holdings while short-term and inflation options the minority.

As mentioned above, if getting educated and choosing funds on your own is something that you are comfortable, go for it and maybe do some added reading and/or talk to an investment expert to fine tune your portfolio. If figuring all this out sounds like too much effort or you don’t want to take this on, simply pick the model portfolio that fits you, then check in every year to ensure it still does and keep contributing through the ups and downs. Over time, we think you’ll find you are on a sound road to financial independence.


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