According to financial adviser Ray Martin, how you allocate your 401k portfolio has a bigger impact on the fund's eventual value than the individual stocks you choose. In other words, the types of investments you choose and the percentage of your portfolio you allocate to stocks, bonds and cash matters more than the actual stocks and bonds you purchase. How much your allocate to each category depends on how long you have to invest and your individual appetite for risk.
1. Study all the offerings of your 401k. You should see an array of different types of investments, from stock funds to bonds to cash accounts that earn interest like a typical bank account. Read the prospectus and familiarize yourself with the types of investments in the various funds from which you can choose.
2. Consider how far away you are from retirement. If you'll be working many years before you retire, you have a lot of time for your 401k to grow, and you can ride out the ups and downs of market fluctuations. If you only have a few years to go before you start withdrawing money from your 401k, you'll have less or no time to recover from market drops.
3. Assess your willingness to take risks. Investments are a type of gamble. You're betting the money you invest will grow, but it could just as easily decrease. If you already have a lot of money in other funds, you may decide you can afford to risk more in your 401k in hopes of a big payout. However, if most of your retirement savings are in one fund, you'll want to play it safe.
4. Choose your allocations based on your appetite for risk and the time you have until retirement. Traditionally, stock funds are the riskiest investment, so they are more appropriate if you're a long way from retirement and/or you're willing to risk more. Bond funds carry less risk than other types of investments. Cash accounts and bank investments, such as certificates of deposit, carry the least risk, and also will pay the smallest return.
5. Divide your investments among several options. Sinking all your funds into cash accounts lowers your risk, but also lowers your potential returns. Accordingly, you might decide to invest 40 percent of your fund in cash, 40 percent in bonds and 20 percent in stocks. Or, someone just starting out in the workplace might put 80 percent of his money in stocks, 20 percent in bonds and nothing in cash.
6. Leave your investments alone once you've made your choice. Constantly changing your allocation ratios in an attempt to game the market usually backfires, since changes will incur fees that eat into your portfolio's value.
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