How to Allocate your 401(k) or other Company-sponsored Retirement Plan Dollars
As a Financial Adviser, I often get asked by clients how they should be allocating their retirement dollars inside their company retirement plan. This is a tough area to tackle for any financial adviser because of the rules surrounding providing advice on 401(k)s and other retirement dollars. Generally, advisers are prohibited in providing advice on such matters. We can, however, provide information that helps the the participant to make their decisions. In this article we will attempt to cover the process that helps you determine your ideal position within your retirement plan.
- Step 1 Determine Your Risk ProfileWe have all heard the term “risk profile,” but what does that mean? A risk profile simply is a range of expected returns relative to the expected variance you are willing to accept on those returns. Stated another way, a risk profile is a determi- nation of how aggressive you are willing to be in growing your money, knowing and accepting the downside risk of loss.
A risk profile can be figured in several ways. Some firms have access to software that takes you through a series of ques- tions to help determine a risk profile. Others may even have a built-in tool on the 401(k) site that allows for a risk profile determination. If your company-sponsored plan does not have a feature like this, you can always consult your financial professional to guide you through the process.
As a rule, the longer you have before retirement (or the goal for the money), the more aggressive the profile. This is not always the case but is generally accepted as a rule of thumb. - Step 2 Stocks, Bonds, or Cash? How to divvy up your investment selections can seem daunting. The average 401(k) plan has around 27 funds in it, according to research by Brightscope**. This number can grow to thousands if you have a brokerage account for your company plan, typically offered as a SEP or SIMPLE IRA plan. For the DIY enthusiast, you can typically match up your recommended allocation percentages on various asset classes (stocks, bonds, cash etc.) that coincide with your risk profile, with what is offered in your plan for these various asset classes. For example, your risk profile might indicate you should be no more than 25% in Domestic Large Company Stocks. You would then look at what funds are offered in that category on your plan’s website and select the fund you felt most appropriate.
Some criteria you may apply to your fund selection might include risk vs. reward metrics, how long the fund has been around for, or a “Morningstar” fund rating within its peer group, to name a few.
For the investor that wants a more hands-off approach, there are often investment services offered within the plan. For example, the plan might have an outside investment adviser manage a portfolio within the plan for a small additional fee (e.g., 0.10 - 0.50%). Or there might be Allocation or Model portfolios for you to choose from which coincide with your risk profile. An example could be that your profile tested out as a “moderate” investor. In this case, you might select a “Moderate Allocation” fund/model in the plan. For the simplest of approaches, often a plan will have retirement or “target-date” options. These are mutual funds which are targeting a certain date that coincides with when the participant most closely reaches age 65. These funds do not stay static like a “conservative” allocation fund, or “moderate growth” allocation fund, whose risk and return targets stay relatively fixed based on their goal. Rather, these funds glide from more aggressive the further out the date, to more a conservative mix as that date approaches. These tend to be more of a one-size-fits-all strategy, and may be suitable for some, but may lack the specificity that savvier investors might desire in a retirement account. - Step 3 Future and Current This last step is simply meant to triage and avoid some unintended mistakes when making these changes to your retirement plan investment choices. First, you will want to make sure your current mix of funds went into the new funds. Often this is labeled as a “Transfer” in the online dashboard, as you are transferring from some of your funds into other investment choices. Secondly, you will want to make sure that not only are your current positions changing to reflect your updated risk and return objectives, but that you are also changing where your contributions go. Some retirement plan dashboards are set up to make sure you are making both selections to reflect your new fund choices. If yours does not direct you to change/confirm your future contributions, then you may need to go and make those changes as well.
Lastly, we need to mention rebalancing for those who chose the DIY option and elected to choose your own investment options rather than using an allocation model or retirement date fund as your selection. The market, as we all know, moves throughout the year. This means that your current fund percentage allocations will also move throughout the year. This can cause portfolio drift and reduce the risk/return efficiency on your portfolio (meaning taking more risk for less return than the original portfolio would have done had the percentages stayed on target). This drift can require a rebalancing of the investment selections to stay in line with your risk profile. As an example, you may have originally allocated 25% to your plan’s Large-Cap Fund offering, but a year later that number has drifted to 40% of your total portfolio. This drift can push your portfolio out of efficiency and out of your desired risk profile. This is where, from time to time, you will want to rebalance your portfolio back to your original intended percentage allocations according to your risk profile. A general rule is to do this once a year.
Conclusion
There are a few important steps in making sure the allocations in your retirement plan fit you like a good pair of shoes and continue to do so as your march towards your financial goals. All these steps can be done with- out the help of a financial adviser. However, you may want the guidance on certain steps - like completing a risk profile - to make sure you are getting it right. When in doubt, ask for help. If I’ve learned one thing in helping clients invest for their goals, it’s that there is no one-size-fits all approach.
Bradley Ruh Owner, Financial Adviser
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