401k Investment Management – Focus on Stock Funds
In your 401k you do the investment management by picking from the investment options offered. Investment companies do the management within these funds, most of which are stock funds. That’s how most 401k plans work, and here’s how to simplify your investment management decision making.
If your 401k plan is typical it might offer a stable (safe) account and maybe company stock as investment options. The rest of your choices are mutual funds, and most of these are stock funds. The first and most important investment management decision you need to make is called asset allocation, and it should focus on stock funds. Where should you invest your money (your ongoing contributions to the plan)? Specifically, what percent of your retirement nest egg are you willing to put at risk in stocks in an attempt to grow your money and earn a higher rate of return over the long term?
Answer that last question honestly based on two factors: your age or how long until you plan to retire, and your risk tolerance. Until you have honestly answered that question, there’s no reason to go any further in your decision making or investment management. For the sake of simplicity, let’s say you decide to be moderately conservative with half going to stock funds with the other half going to the safe stable account that earns interest. You already have a few thousand invested in your 401k and decide to move that money to the same asset allocation of 50-50. Now, the question is which stock fund or funds should you pick? Note that a stock fund is often referred to as an EQUITY fund.
As an inexperienced or average investor your objective in picking equity funds should be to participate in the stock market, not to take excessive risk in an attempt to beat the market. Your plan literature will likely describe or classify the various equity funds offered in terms of relative risk and/or large-cap vs. small cap and/or growth vs. value, and/or diversified vs. non-diversified. Look for a DIVERSIFIED equity fund with AVERAGE RISK that invests in LARGE-CAP stocks for both GROWTH AND INCOME. Such a fund might be called a DIVERSIFIED LARGE-CAP GROWTH AND INCOME or EQUITY INCOME FUND. It will invest primarily in stocks of large companies, some of which you are familiar with like GE, IBM, American Express, and so on. Learn more about Portafina
What the moderate and inexperienced investor wants to avoid are the riskier funds: small-cap funds invest in smaller riskier companies, growth funds have higher risk and pay small dividends, and non-diversified (or specialty) funds focus on certain areas or industries that can go into or out of favor. You want to be diversified and be invested in major corporations, to participate without extra risk. If available, the perfect equity fund for the average investor would be one that tracks a major market index like the S&P 500 or Dow Jones Industrial Average. Specifically, an S&P 500 Index Fund holds 500 major stocks… basically of the 500 most valuable public corporations in America.
Once you have selected one or more equity funds to invest in, investment management now becomes an ongoing process. At least once a year review the asset allocation in your 410k account. Look at your total account value. If your asset allocation to equity funds is more or less than 50%, move money to or from your safe account to make both equal again. Keep your new money going in (your contributions) the same at 50-50, as well. This is how I suggest that average investors handle investment management in their 401k to keep things simple while keeping risk under control.