3 ways to tell if your 401 (k) is too aggressive
A 401 (k) retirement plan is one of the most popular ways to save money for retirement and get tax breaks for doing so. But often these plans don’t provide much advice on how to manage them, and participants end up with extremely aggressive portfolios, or, what experts often see, a portfolio so conservative that it barely budges year after year. year.
Here’s how to see if your 401 (k) is too aggressive, and if so, there are steps you can take to correct it.
Being too aggressive can be a problem
When experts speak of aggressiveness, they usually mean the portion of your assets in stocks or equity funds. With their long-term record of annual returns of 10%, stocks are an attractive investment, but they fluctuate a lot in the short term. This is problematic, especially for investors who will be retiring soon.
While being more aggressive can make a lot of sense if you have five or 10 or more years to retire, it can really cost you money if you need that money in less than five years. To reduce risk, investors can add more bond funds to their portfolio or even hold some CD.
“A sharp drop in the market immediately before retirement can have devastating effects on a retired person’s standard of living,” says Dr. Robert Johnson, professor of finance at Heider College of Business at Creighton University.
Johnson cites those who retired at the end of 2008 and only invested in the Standard & Poor’s 500 (S&P 500) Index, which contains hundreds of leading companies. “If they had been invested in the S&P 500, they would have seen their assets drop 37% in one year,” he says.
But those who had invested in other assets such as bonds or even cash would have seen a much smaller overall drop. Of course, any money in the S&P 500 would have shrunk by a similar amount, but by having fewer eggs in that basket, their overall portfolio shrank less.
This principle of diversification is huge to make sure your wallet isn’t too aggressive.
But many workers make the opposite mistake, not investing aggressively enough. If you’re over five years to retirement, and certainly if you’re 10 or more, you can afford to be more aggressive because you have time to weather the ups and downs of the market.
3 signs your 401 (k) is too aggressive
If you think your wallet may be too aggressive, here are a few signs to look for.
1. Your account balance fluctuates a lot
It can be exciting to see your balance increase quickly, but it’s important to realize that this could be an effect of a 401 (k) that is invested too much in equity funds and not enough in safer alternatives.
“If you take someone with an account balance of $ 100,000 and after a month their account is now $ 110,000, which is 10% growth in a month, what that tells me is that ‘he probably has most of his money in stocks,’ says Matthew Trujillo. CFP at the Center for Financial Planning in Southfield, Michigan.
“It will feel good when things get better, but this investor needs to be prepared for some big paper losses when we go through a recession like the one we just saw in March and April,” says Trujillo.
2. You worry a lot about your 401 (k)
If you are very concerned about slowdowns in your 401 (k), you may be investing too aggressively.
“If someone has a tendency to quit their investments because of volatility, the portfolio is probably too aggressive for them,” says Randy Carver, president and CEO of Carver Financial Services in the Cleveland area.
But it’s critical to understand that while stocks are more volatile and you don’t always feel comfortable owning them, they’re also one of the best ways to grow your wealth over time, especially in an era of low interest rates and low bond yields.
“If they’re not invested to grow enough to meet long-term needs, that’s too conservative,” says Trujillo. “The key is to look at longer periods, two or three years or more, to see trends, not just one or two months.”
3. You need cash soon, but your 401 (k) has none
If you know you’re going to need cash for the next few years, your 401 (k) needs to factor that in. This doesn’t mean you have to sell everything and make cash now, but you can leave new cash contributions or transfer them to low-risk bond funds, slowly reducing aggression.
To gauge the aggressiveness of your plan, use the rule of 100, suggests Chris Keller, a partner at Kingman Financial Group in San Antonio. With this rule, you subtract your age from 100 to find your allocation to equity funds. For example, a 30 year old would put 70% of a 401 (k) in stocks. Naturally, this rule makes 401 (k) less risky as retirement approaches.
Emphasizing the importance of a 70-year-old reducing risk, Keller says, “Losing half your portfolio at that age can have a huge impact on your retirement.”
What you can do if your wallet is too aggressive
Investors who find their portfolios too aggressive have potential solutions to this problem that range from a simple one-off move to overhauling your financial plan with a financial advisor.
The first step is to reduce the risk of your portfolio by shifting some exposure into equity funds (or more risky options) in bond funds or even cash, depending on when you need it.
A good way is to find a asset allocation between stocks, bonds and cash that meets your needs and your temperament. A more aggressive allocation might have 70% or more in equities, while a more conservative allocation might have the same in bonds. Then stick to that allocation and rebalance it when it goes too far from your target allocation.
“This means that often a market correction is a good time to move more into stocks, not less,” Carver says. “The key is to stick to a target allocation that eliminates the need to make decisions based on market behavior or forecasts.”
If you are managing the portfolio yourself, Johnson recommends starting risk reduction maybe up to five years before you want to access the portfolio. This does not mean that you should use up all cash and bonds, but rather gradually shift the portfolio towards lower total risk.
If you don’t want to make these changes yourself, use a target date fund to handle the process for you. It automatically transfers money from stocks to bonds as you approach your target date, which may be retirement, but can be anytime you need to start withdrawing money.
Another good option is to meet with your own advisor and your company’s 401 (k) advisor each January, says Paul Miller, managing partner of Miller & Co. accounting in the New York area.
“It’s critical for an employee to hear what they have to say,” Miller says. “Take notes, then go on the web and read the notices for each fund. For example, you can use Morningstar to independently rate and review your funds. “
Finally, it may be helpful to have your 401 (k) reviewed by a financial advisor, but you should find one that works in your best interest and not one who is paid to put you in certain financial products. Here’s how to find the right advisor for you.
At the end of the line
“It’s important to note that a retirement date is not the finish line – even if someone has to retire at 60 or 65, the funds might be needed for another 20 to 25 years,” Carver said. “They should continue to be invested in a diversified allocation that has growth potential.”
So, even as you age and take a less aggressive approach to investing, it’s essential to remember that you probably still need some exposure to stocks in your portfolio and plan accordingly.