Making Sense of Your 401(k) Options

For most participating in a company 401(k) plan, it can be difficult to confidently create a portfolio that aligns with one’s financial goals and objectives. The challenges vary from the confusion around expenses to the limited menu of stock and bond mutual fund options; not to mention the illusion of diversification. So how do you make sense of your options and construct a portfolio you can have confidence in? Below are a few steps to help get you started!

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Start with Asset Class Allocation 

To determine the appropriate stock-to-bond ratio within your 401(k), you must first establish goals for wealth accumulation. For most, the primary goal is accruing enough money to maintain a confident lifestyle after retirement. So, what is considered “enough money?” That answer varies based on an individual’s retirement plan. To help understand what that means for you, here is a three-step process to follow:

  1. Determine your annual spending and then adjust for inflation to determine what the inflation adjusted number will be at retirement (*Recommendation: Use a minimum of 2% inflation adjustment for each year between now and retirement).
  2. Determine how much cash flow you can expect from sources, such as pensions, social security, etc. at retirement.
  3. Subtract #2 from #1 and then divide this number by 3.5% or 0.035 (*3.5% is a solid withdrawal rate goal on your accumulated retirement principal). The resulting number from this calculation is the amount of money you need to accumulate before retirement. Now, based on reasonable rate of return assumptions and assumptions about how long you intend to work, you can determine the asset allocation required to achieve your long-term accumulation goals (*Recommendation: 8% for stocks; 2% for bonds/fixed income/cash).

Diversify Within Asset Classes

Once asset class allocations are determined, look to diversify within those asset classes. For stocks, look to expand your exposure across US Large Cap, Mid and Small Cap, International, and Emerging Market stocks. Be sure to look to your time horizon, also known as the timeline for when investors plan to gain value in their investments. It is important to make sure you are more focused on managing downside risk the closer you are to retirement (See below for help with risk determination).

Understand Risks and Expenses within Asset Classes

One of the easiest ways to determine how much risk you are taking in your investments is what is known as “Beta.” Beta is an indicator of relative risk to the broader market, which has a Beta of 1. If a fund/stock has a Beta greater than 1, it involves greater statistical risk than the broader market. Inversely, if Beta is less than 1, it involves less statistical risk than the broader market. A quick internal look at each investment option should provide you with the Beta for each investment option. If you have trouble finding it, contact your plan custodian (i.e., Schwab, Fidelity, etc.) and ask for help. Finally, it also makes sense to evaluate the underlying expense ratios of your various investment options. This analysis may bring to light less expensive investment options with better historical performance. While analyzing these expense differences is an important factor, it shouldn’t be your primary driver of your investment decision.

Managing a 401(k) can seem very daunting, but it is well worth it to reach your financial goals by retirement. If you have any questions on how to get started or how to improve your portfolio, consult with a Financial Planner to help you work towards your goals.

 

Marshall Clay CFP, J.D., is a Partner and Senior Advisor at The Welch Group, LLC, specializing in providing Fee-Only investment management and financial advice to families throughout the United States. Marshall is a graduate of the United States Military Academy in West Point, New York, the Cumberland School of Law in Birmingham, Alabama, and is a CERTIFIED FINANCIAL PLANNER™.  In addition, Marshall is a frequent guest on local television stations as an expert on various financial planning matters.

 

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Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by The Welch Group, LLC –(“Welch“), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Welch. Please remember that if you are a Welch client, it remains your responsibility to advise Welch, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Welch is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of Welch‘s current written disclosure Brochure discussing our advisory services and fees continues to remain available upon request or at www.welchgroup.com. Please Note: Welch does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to Welch‘s website or blog or incorporated herein, and takes no responsibility.