Building a 401(k) portfolio

A 401(k) portfolio is a collection of investments you assemble by selecting among the choices your plan offers. The best portfolio for you is one that produces the strongest possible long-term growth at the level of risk you’re comfortable taking. You can make portfolio changes as investment alternatives are added, as you get closer to retirement, and also as market conditions change.

Figuring what you’ll need

To calculate the income you’ll need for retirement, you’ll need to account for:

  • Your current salary
  • The number of years until you plan to retire
  • The amount you have already saved
  • The potential inflation rate
  • The estimated real rate of return, or what you can expect to earn on your investments after adjusting for inflation

You can use a retirement planning calculator to help you figure out what you’ll need. These calculators are available online on many financial services sites. Check your mutual fund company, bank, broker, or insurance company, or a site that specializes in 401(k)s.

Basic strategies

To get a feel for putting a 401(k) portfolio together, take a look at these three hypothetical combinations. Each is designed to show a level of risk-taking that might be appropriate at a particular stage in your career. Unless you invest your 401(k) using a brokerage account, and purchase individual securities, these allocations apply to various funds available through your plan.

 

Years to RetirementLarge-Company StocksSmall-Company StocksInternational Stocks Balanced FundsLong-Term BondsMoney Market
20 or more 35% 30% 15% 10% 10% -
10 to 20 35% 20% 15% 20% 20% -
5 or less 20% 10% 10% 20% 30% 10%

Getting started

Building a strong 401(k) portfolio isn’t easy. But it’s worth the time and effort it takes. Whether you’re making investment decisions for the first time, or as part of putting your retirement savings portfolio in shape, you’ll want to consider five key factors:

Other retirement assets
It’s important to know what portion of your long-term retirement planning your 401(k) account represents. If it’s just one part of a total portfolio that includes an individual retirement account (IRA), taxable investments, and perhaps a pension or deferred annuity, you may be comfortable concentrating your 401(k) contributions in just one or two of the best-performing alternatives your plan offers.

But if your 401(k) is the only money you’re putting away for retirement, you may want to balance your portfolio, seeking the greatest possible growth while diversifying to reduce risk.

Your age
If you have many years of work ahead of you, you can afford to take greater risks with your 401(k) account. If an investment doesn’t perform well for a period — because the manager’s investment style is out of favor or the stock market overall is in a slump — you’ll have time to recoup the loss.

On the other hand, if you’re planning to retire fairly soon, you may want to gradually shift at least some of your assets into less volatile investments to preserve capital, or hold on to what you’ve got.

Your future income needs
Projecting your future income needs can tell you how aggressively or conservatively you should invest and how much you can afford to withdraw each year. Experts agree that you’re likely to need at least 70% to 85% of your final preretirement income to live comfortably after you stop working.

Your tolerance for risk
The risk-return tradeoff you’re willing to make is a key element in your investment decisions. There’s historical evidence that investments posing a greater risk to your principal offer potentially greater returns. But if you’re not comfortable assuming risk to principal, it’s best to recognize the consequences of inflation risk on your long-term buying power.

Your current tax bracket
The extent to which you can minimize current and potential future income taxes should be a factor in deciding what types of investments are best suited for your different accounts. But remember that some tax benefits do change periodically, often depending upon the political and economic situation at the time.

 

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