A 401(k) plan is the primary investment vehicle for most workers. Contributions to a 401(k) generally form the biggest annual investment of funds, and a 401(k) portfolio is often the most valuable asset held by retirees. However, many people also hold other investments: in real estate, via a brokerage account, or in savings accounts.
For investors looking to follow an integrated strategy, it’s crucial to take into account these other forms of investment when planning what to put in your 401(k) plan. In this article, we’ll look at a number of popular investment strategies and how they may affect your 401(k) asset allocation.
- There are many investment strategies that focus on asset allocation—the relative value of different asset classes such as stocks, bonds, and real estate within a portfolio.
- If you hold investments outside of your 401(k), you should make sure that your desired asset allocation holds true across your entire portfolio.
- You should undertake regular audits of all the assets that you hold—both in your 401(k) account and outside it—to make sure that your portfolio is well-balanced.
Coordinating Your Investments
If you manage your own investments, it’s important that you look at them in a holistic way. Over the course of a lifetime, you might end up with many different types of investment accounts, as well as a very diverse set of investments held within them. To make the most of your investments, it’s important that they work well together.
At the most basic level, this involves being aware of the investments you hold and making sure that they reflect your desired asset allocation. Doing this will require that you perform a regular audit of all your investments—those held in your 401(k) account, in your brokerage account, and in savings accounts that you may not pay much attention to otherwise. This audit should also include your spouse’s accounts, and particularly their 401(k).
Armed with this information, you can calculate your true asset allocation—the value that you and your family hold in stocks, bonds, commodities, and other types of assets. If you are performing this audit for the first time in a while, you’ll likely find that your portfolio is not as neatly balanced as you thought it was.
The simplest example of this is an investor who holds just one target-date fund in their 401(k). This type of fund automatically adjusts asset allocations as an investor approaches retirement age, and it is a popular way to automate portfolio management. However, the formula that a target-date fund uses to calculate the optimum asset allocation assumes that you hold no other assets. A target-date fund might be composed of 50% equities by the time it approaches its terminal date, but if you hold a lot of equities in a brokerage account, it will affect this ratio for your portfolio as a whole.
Even carefully managed portfolios can become unbalanced in this way. There is, for example, a popular rule that the percentage of your money invested in stocks should equal 100 (or 120, according to some) minus your age. Again, this formula is designed to apply to your entire portfolio, not just your 401(k); thus, if you hold a lot of stock in your brokerage account, you should weight your 401(k) portfolio away from stocks to follow the rule. The same principle applies to almost any asset allocation approach.
Asset allocation and risk tolerance are measured across your entire investment portfolio, not just your 401(k). A failure to realize this could either leave you exposed to more risk than you are comfortable with or lead you to miss out on higher returns.
Balancing Your Portfolio
In principle, balancing your portfolio, and your 401(k) as part of that, is a simple business. You decide on an asset allocation strategy that you are comfortable with, then regularly check in with your accounts to ensure that they reflect this.
This is, in fact, a crucial process for any actively managed portfolio, no matter how many investment accounts you have. Even within a 401(k), you’ll likely find that one part of your portfolio grows more quickly than another—for example, it might be that your stock funds increase in value more quickly than your bond holdings. In this case, you should buy more bonds to keep the value of your assets in line with your strategy.
There are various ways of automating this process, with the most popular being a target-date fund. However, target-date funds are optimized for investors who hold nothing else, and if you have a separate brokerage account, this can limit their advantage. In this situation, the best advice is to keep the asset allocation in your brokerage account (and, indeed, across all your investment accounts) close to that of your target-date fund.
Finally, keep in mind that there are a number of features of 401(k) plans that make them very different from a regular brokerage account. Specifically, you won’t pay tax on the money you invest in a 401(k) account until you take it out again in retirement, and these accounts have required minimum distributions (RMDs).
These features can make coordinating your 401(k) portfolio with your other investments far more complicated. Because of this, if you have significant investments outside your 401(k) and plan on accessing these as part of your retirement planning, it’s worth consulting an expert to make your planning as tax efficient as possible.
What is the best asset allocation for a 401(k)?
That depends on your risk tolerance and investment style. A popular rule is that the percentage of your money invested in stocks should equal 100 (or 120, according to some) minus your age. If you plan to follow this rule, however, you should apply it across all your investments, not just to your 401(k).
What is the advantage of a target-date fund?
Target-date funds are a popular way of automating portfolio management, and they will automatically adjust your asset allocation as you near retirement. However, they are designed to be held on their own, meaning that your portfolio can become unbalanced if you have a target-date fund and a brokerage account.
How can I keep my 401(k) balanced?
You should regularly audit your 401(k) to make sure that it holds a mix of stocks, fixed-income, and other assets that you are happy with. Most portfolios will require occasional adjustments to keep the value of these assets in balance.
The Bottom Line
There are many investment strategies that focus on asset allocation—the relative value of different asset classes such as stocks, bonds, real estate, cash, and commodities within a portfolio. If you hold investments outside of your 401(k), you should make sure that your desired asset allocation holds true across your entire portfolio. You should undertake regular audits of all the assets you hold—both in your 401(k) account and outside it—to make sure that your portfolio is well-balanced.