Without training we're expected to guess what will happen in the economy for the next 40 years until we retire. Our crystal ball algorithms are still in the beta phase, but until then here is some logic to making easier choices for your 401(k).
By Tim Plaehn / Illustrations By Andrew Snavely
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You are now in the workforce and have a decent job with good benefits including a 401(k) plan. For someone in their 20's, 401(k) money is a glimpse into your future 40 years from now. Trying to decide what to do with money with a 40-year horizon is a bit daunting. Think of 40 years back in 1973 – cars all had V-8 engines, gasoline was full of lead, there were three TV channels in most homes coming in by antenna and advanced calculations were done with slide rules.
To not try to guess what will happen over the next 40 years, you need a shorter-term plan to allocate your 401(k) savings. The goal is to have a portion of your 401(k) money in different asset classes which should each have their day – or decade – of above average performance. The scenario you want to avoid is to have most of your money in one type of investment, then have that investment do really, really well – until you start to believe in your own investment picking genius – to be followed with that investment going into the tank.
And all hot investment classes – stocks, bonds, real estate, gold and collectibles – eventually have their bubble burst with serious drops in value. These assets eventually come back, but it is not a good thing to have half of your retirement account disappear and then have to start building it up again.
Asset Classes
Before discussing some allocation strategies, let us take a look at some of the asset classes you would like to have in your 401(k) plan. What you can do depends on the investments offered by your employer, but most plans offer a range of mutual funds. As the world of financial products continues to change, your 401(k) may eventually offer ETFs (exchange-traded funds) as well as mutual funds.
New to 401(k)'s? Check out “What the Hell is a 401(k)“.
Look through the fund offerings of your 401(k) plan and make a note if you have access to any of the following types of funds:
- High-Yield Bond Fund – High-yield bonds are corporate bonds from companies with less than investment grade credit ratings. Besides paying attractive yields, the market values of these bonds cycle with the economy. When the economy gets bad, high yield bonds generally get cheap and increase in value as things improve. For someone in their early working years, high-yield bonds are a better investment choice than other types of bond funds.
- Real Estate Fund –Real Estate Investment Trusts – REITs – are publicly traded companies which own commercial real estate such as office buildings, shopping centers, storage units and industrial commercial properties. A real estate focused mutual fund will hold a portfolio of REIT stocks and other related companies.
- Natural Resources Fund– It would be great to own a gold bullion ETF in your 401(k). However, most plans do not include ETFs, so the next best thing will be a mutual fund focused on natural resources stocks. This type of fund will own companies which earn profits from natural resources such as mining companies, oil companies and timber companies.
- Emerging Markets Fund –The emerging market economies are predicted to grow twice as fast as the developed economies of North America and Europe. Emerging market funds will provide a wild ride, but the long term results should be way above average.
Allocating Your 401(k) Assets
Along with the four types of funds discussed above, you should pick out one or two domestic stock funds from the list available in your 401(k). As a result you will have five or six funds into which your contributions will be credited. Initially, divide any existing 401(k) account balance and your future contributions equally into the selected funds. It is impossible to guess which asset class will outperform over the next several years, so an even allocation makes as much sense as anything else.
Let your 401(k) assets build in value for a couple of years and then start to re-balance back to your original allocation every 6 months or annually. Many 401(k) plan administrators let you set up automatic re-balancing. Take advantage of this feature if you have it available. It will take a while – possibly several years – before true performance differences start to show. The best course of action at this point is no action. Let the funds and asset classes work through the natural short term swings and allow the longer term trends to build value in your retirement account.
A final word: If you can buy company stock in your 401(k), limit the allocation to no more than 10% of you retirement account value. Your company may be the greatest thing since the iPhone, but the fortunes of a single company can change rapidly. Your 401(k) is a 40-year work in progress. Always keep that fact in mind.
Of course, everyone's situation is a bit different, so check with a financial planner before making changes.
FAQs
As a rule of thumb, you can subtract your age from 110 or 100 to find the percentage of your portfolio that should be invested in equities; the rest should be in bonds. Using 110 will lead to a more aggressive portfolio; 100 will skew more conservative.
Is 20% enough for 401k? ›
As a rule of thumb, experts advise that you save between 10% and 20% of your gross salary toward retirement. That could be in a 401(k) or in another kind of retirement account. No matter where you save it, you want to save as much for retirement as you can while still living comfortably.
What is the average 401k balance at 20? ›
Average 401(k) balance by age
| Age | Average 401(k) account balance |
|---|
| Under 25 | $5,236. |
| 25 to 34 | $30,017. |
| 35 to 44 | $76,354. |
| 45 to 54 | $142,069. |
2 more rowsFeb 16, 2024
Starting early and contributing to a 401(k) in your 20s is crucial for long-term financial security. Aim to save at least 15% of your pretax income for retirement. Take advantage of employer matching contributions to maximize your savings.
How much should I allocate to 401k? ›
You should aim to contribute enough from each paycheck to take advantage of any employer match. If your employer offers a 3% match, contribute at least 3% of each paycheck to your 401(k). After you reach the match, increase your contributions when you can afford to, aiming for 10% to 20% of your paycheck each month.
How do I calculate allocation percentage? ›
Other Allocation Methods
If the auditor's cost is based on the Total Revenue of the organization, then you would divide the total revenue of this program by the total organizational revenue, to calculate the allocation percentage for that cost.
What does 20% 401k match mean? ›
Matching 401(k) contributions are the additional contributions made by employers, on top of the contributions made by employees. These matches are made on a percentage basis, such as 25%, 50% or even 100% of the employee's contribution amount, up to a limit of total employee compensation.
Can I retire at 62 with $400,000 in 401k? ›
If you have $400,000 in the bank you can retire early at age 62, but it will be tight. The good news is that if you can keep working for just five more years, you are on track for a potentially quite comfortable retirement by full retirement age.
Is 20 percent enough for retirement? ›
But how much is enough? Our guideline: Aim to save at least 15% of your pre-tax income1 each year, which includes any employer match. That's assuming you save for retirement from age 25 to age 67. Together with other steps, that should help ensure you have enough income to maintain your current lifestyle in retirement.
What is the ideal 401k balance by age? ›
However, the general rule of thumb, according to Fidelity Investments, is that you should aim to save at least the equivalent of your salary by age 30, three times your salary by age 40, six times by age 50, eight times by 60 and 10 times by 67.
And by age 60, you should have six to 11 times your salary saved in order to be considered on track for retirement.
What is 20 percent retirement savings? ›
One popular budgeting method, the 50/30/20 budget, recommends setting aside a total of 20% of your paycheck for your savings goals, including the magnum opus: retirement. Experts say that's a fair rule of thumb.
Is $100 a month good for a 401k? ›
Your Retirement Savings If You Save $100 a Month in a 401(k)
If you're age 25 and have 40 years to save until retirement, depositing $100 a month into a savings account earning the current average U.S. interest rate of 0.42% APY would get you to just $52,367 in retirement savings — not great.
Are 401ks still a good idea? ›
While 401(k) plans are a valuable part of retirement planning for most U.S. workers, they're not perfect. The value of 401(k) plans is based on the concept of dollar-cost averaging, but that's not always a reliable theory. Many 401(k) plans are expensive because of high administrative and record-keeping costs.
Is a 401k worth it in your 20s? ›
Yes, you should start saving for your retirement in your 20s. Though retirement may seem far off, saving for it as early as possible will ensure you have enough money to get you through your retirement years.
What should my 401k allocation be at 55? ›
As you reach your 50s, consider allocating 60% of your portfolio to stocks and 40% to bonds. Adjust those numbers according to your risk tolerance. If risk makes you nervous, decrease the stock percentage and increase the bond percentage.
What should my allocation percentage be? ›
For years, a commonly cited rule of thumb has helped simplify asset allocation. According to this principle, individuals should hold a percentage of stocks equal to 100 minus their age. So, for a typical 60-year-old, 40% of the portfolio should be equities.
What is the 4% rule for asset allocation? ›
The 4% rule is a popular retirement withdrawal strategy that suggests retirees can safely withdraw the amount equal to 4% of their savings during the year they retire and then adjust for inflation each subsequent year for 30 years.
What is a 70 30 allocation? ›
The old-school approach for many investors and financial advisors has traditionally been to structure an investment portfolio on a 70/30 basis (or similar figures). This strategy allocates 70% of an investor's funds to equities or equity-focused investments, and 30% to bonds, or fixed-income investments.
