401K Asset Allocation: Making it Work for You

Learning about 401k asset allocation can be one of the best things you can do when planning for retirement. Asset allocation is a very important concept to understand and it can help you improve the performance of your overall portfolio. The term asset allocation deals with what types of investments you put your money into. The individual stocks or mutual funds that you put your money into are not critical to asset allocation. Asset allocation instead deals with how much of your portfolio will be allocated to a specific class of security.Here are a few things to consider about 401k asset allocation and why it is important.

Asset Allocation

Asset allocation does not refer to the different options that you have within a particular asset class. For example, with asset allocation, you will put a certain amount of money into stocks, a certain amount of money into bonds, and a certain percentage into mutual funds. 

Importance

Dealing with asset allocation is critically important if you want to live a comfortable life during retirement. By putting different amounts of money into different asset classes, you can realize different investment benefits. Since different financial markets behave differently, you may be able to weather financial storms better and hang onto the money in your 401k over the long-term. 

For example, if you do not practice asset allocation, you might put all of your money into the stock market. You invest in a few different stocks with your money. Then, one year, a stock market crash occurs and the value of your stocks declines to nothing. When this happens, your entire retirement savings is gone. If you had practiced asset allocation and put a certain percentage of your portfolio into bonds, you may have been able to weather the storm. When the stock market decreases in value, bonds can still keep providing you with income. However, you do not want to put too much of your portfolio into bonds because you can be giving up better returns in the stock market or from mutual funds.

Changing Allocation

Everyone should plan on practicing asset allocation with their retirement portfolios. However, the degree to which you put money into different assets will change depending on how old you are. If you are very young when you get started, you could potentially put all of your money into the stock market or into equity mutual funds. As you get older, you should allocate more of your portfolio to fixed income securities and safer mutual funds. By the time you get close to retirement, the majority of your portfolio should be made up of safer investments.

One of the most common formulas for determining your asset allocation is to take 100, and subtract your age from it. The number that you get is the percentage of money in your portfolio that should be in stocks. This is not a foolproof rule, but it does have some merit. With this strategy, every year you will take some of the money in stocks and move it over to bonds.

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