How to Turbocharge Your 401(k) for 2016 By Betterment
A pilot relies on myriad indicators in the cockpit to help make the right decisions to safely fly a plane. The indicators reveal direction, altitude, velocity, wind speed and fuel level.
If one of the gauges is not within its proper boundaries, the pilot makes corrections to stabilize conditions. Without these dashboard indicators, the pilot would be putting his passengers and crew at serious risk.
Managing your 401(k) portfolio can be accomplished in much the same way. It requires a flight plan combined with an allocation dashboard. The process of developing your allocation dashboard will clarify your goals and methods for reaching them. It should be an essential part of your retirement planning.
All too often, 401(k) investors don't follow an allocation dashboard, which means they're flying blindly. Because 401(k) plans are invested for the long haul, investors tend to push them to the back of their minds and neglect calibrating their holdings according to an asset allocation strategy. Over the years, that sort of neglect can dampen gains and increase risk.
Asset allocation is a continual process, not a one-time event. It is the process of selecting among disparate investment choices and combining them to achieve adequate returns while reducing volatility.
Asset allocation is one of the most crucial decisions in investing. Investors build long-term wealth through three basic activities: selecting specific investments to buy; deciding when to get in and out of the markets; and establishing asset allocation.
The first two activities are the hardest and least forgiving. However, asset allocation is the easiest to determine and it wields the most power.
According to some financial industry studies, asset allocation explains 93.6% of the variation in a portfolio's quarterly returns.
An asset allocation policy entails dividing a portfolio's investments among different asset classes. The most common classes are stocks, bonds, cash and metals. Your allocation should be designed to provide an easy and transparent way for you to determine how your investments are performing.
Keep in mind, we're not referring to market timing. A common misconception is that you must time the market to succeed with your investment goals. Not so. In fact, most investors who try to invest at "just the right time" do the opposite. They buy when the market has increased and is all the talk around the water cooler, and they sell when the market falls due to adverse political, economic and international events.
Here's a sure-fire contrarian indicator: When your cabbie or shoeshine guy is recommending hot stock tips, the market is overbought and due for a crash.
That's why you should tune out the noise of the chattering class, as well as the market's ephemeral ups and downs. Forge an asset allocation plan predicated on your long-range goals and stick to it. Make adjustments but do so sparingly, as your circumstances and goals evolve.
To make a 401(k) plan really worth it in your younger years, you must emphasize stock mutual funds. The fact is, 401(k) plans are long-term money. And over the long term, stocks have outperformed every other investment vehicle.
If managed correctly, a 401(k) plan is the most powerful method of accumulating retirement assets over the long term. And stocks are the best long-term game in town.
Stocks have historically outpaced other types of investments because they provide the opportunity for growth. That's why 401(k) investors have an advantage -- they can approach the stock market with an eye on the distant horizon.
We'd never advise putting all of you eggs in one basket. But the younger you are, the more heavily you should weigh your 401(k) portfolio toward stocks.
Your Allocation Dashboard
Before establishing your 401(k) portfolio's asset allocation dashboard, first answer this basic question: What's your stage in life?
We suggest these age-contingent categories: 1) relative youth (15 years from retirement); 2) middle age (5-15 years from retirement); and 3) advanced middle age/senior citizen (5 years from retirement).
Here are our suggested allocations:
Cash 10%; Bonds 10%; stocks 70%; metals 10%
Cash 25%; Bonds 25%; stocks 25%; metals 25%
Cash 55%; Bonds 15%; stocks 15%; metals 15%
Choose a category based not only on your approximate age, but also on your tolerance for risk. As long-term market history amply shows, you'll have to withstand a lot of bumps along the way.
If your portfolio is heavily weighted toward stocks and the stock market takes a sharp turn for the worse when you're in you 40s, you still have plenty of time to bounce back. That's why our recommended allocations get safer as you get older.
But remember: If you're still several years away from retirement, the safer you play it, the less effective your 401(k) plan.
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