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Building A 401k Portfolio...Here's Some Tips

Most 401k retirement plans (403b plans too) provide you a "menu" of funds. 

The plan provider generally offers a a group of funds in different investment categories.  Get familiar with terms like large cap, small cap, international stock funds and also different types of bond funds.  Websites like Morningstar can provide helpful information on these investment categories.

How do you know which funds to select?  CNNMoney.com How To Invest Your 401k.

Question: I've got many investing options in my 401(k) -- small caps, large stocks, emerging markets, fixed-income, etc. What would be the ideal portfolio for me considering that I'm 51 and plan to retire at 65?

Stocks vs. bonds

Start by coming up with an overall mix of stocks and bonds that appears appropriate for you. You've got a pretty long investing time horizon -- 14 more years until you retire, plus another 20 to 30 in retirement. So you need capital growth to build the value of your 401(k) between now and retirement and to help maintain purchasing power during retirement. That argues for putting a sizeable percentage of your 401(k) in stocks since over very long periods stocks generally outperform bonds.

That said, we also know that stocks can get whacked for losses of 30% or more occasionally. And at your age you can't afford to lose too big a chunk of your 401(k) balance. You may not have enough time to recoup the loss. So that argues for not going overboard with stocks.

What type of stocks?

If you could foretell the returns of, say, large-cap, small-cap and foreign stocks as well as how they'll move around compared with each other, you could put together an ideal blend.

But you can't. Which is why for the domestic stock holdings in your portfolio, I think you should take your cues from the way investors overall divvy up their money between different types of stocks. To do that, plug the ticker symbol (VTSMX) for Vanguard Total Stock Market Index fund (VTSMX), which tracks the entire U.S. stock market, into Morningstar's Instant X-Ray tool. You'll immediately see how U.S. stock investors allocate their investing dollars by stock size (small, medium and large) and style (value, growth and blend). Unless you think you know something your fellow investors don't, I wouldn't stray too far from those allocations.

It's not a bad idea to diversify your portfolio a bit more by adding some foreign stocks, assuming they're available in your plan. How much foreign exposure? I'd say 10% to 20% of your overall stock holdings in broadly diversified foreign funds ought to do it.

You could also consider branching out into emerging market foreign funds. But don't be unduly swayed by their recent boffo returns. These funds are the investing world's versions of manic depressives, flying high one year, crashing the next. So if you dabble in them at all, they should represent only a small portion of your foreign holdings.

What type of bonds?

Again, I think broad diversification is the key. I recommend that investors consider making a total bond market index fund the core of their bond portfolio. If you want to diversify beyond that into foreign bonds, high-yield and TIPs for a bit of inflation protection, fine. But these options combined probably shouldn't account for more than 10% to 20% of your bond portfolio.

When you've got a lot of investment options, there's an inclination to think you should be using as many as you can. Problem is, the more investments you own, the more complicated it gets to choose, monitor and maintain them in a coherent portfolio.

How many funds do I need?

So I think you're generally better off keeping things simple. To my mind, there's a lot to be said for a portfolio of just three funds -- a total U.S. stock market index fund, a total U.S. bond market index fund and a broadly diversified foreign stock index fund -- that you rebalance periodically. That combo would give you large and small shares, growth and value and international exposure.



Posted on Friday, November 13 by Registered CommenterWise Owl in , | Comments Off