Changing 401k strategy

Q: I’ve invested in my 401k for 11 years now and have experienced many ups and downs, but I didn’t do much research when I started. What’s the best way to invest for retirement?

A: You’re right to step back and start anew with a more methodical, researched approach. I’d recommend you read a good investing book or two like The Coffeehouse Investor, which is both quick and easy to read.

While you won’t be able to avoid the stock market’s downs without also missing out on the gains, you can set yourself up to see more of the latter.

Diversifying your investments will protect you from the steep declines that come with investing too heavily in a specific stock, industry, or type of asset. Your asset allocation should also take into consideration your tolerance for risk.

Understanding your risk tolerance is essential. Overly aggressive investors have lost millions and nest eggs have been shattered by risky investments. Historically, more stock market risk has translated into higher returns, but only when the stocks are held long enough.

Investors who panicked after a bad day, year, or even decade lost money. Holding your age in bonds is one way to control your exposure to stock market risk. For example, a fifty year old investor’s nest egg would be split evenly between stocks and bonds.

And while stocks return more than bonds, their prices fluctuate more wildly which can be disastrous if you are near retirement. To learn more about your comfort with and need for risk, check out William Bernstein’s The Four Pillars of Investing & Larry Swedroe’s Wise Investing Made Simple.

Investing through index funds is the final key to successfully investing in your 401k. Index funds are a basket of stocks that fulfill a specific criteria. For example, the S&P 500 includes the 500 largest American companies based on their market capitalization (the total value of their outstanding stock).

Index funds are the foundation of a successful investment strategy because investment brokers, mutual fund managers, and day traders are not consistently successful. More than 80% of mutual fund managers fail to beat their respective indices.

So the odds that one of your 401k options is a market-beater is very unlikely. And even if one was, how would you even know beforehand?

These three considerations–diversification, reasonable risks, & index funds–will start you towards a secure retirement. To learn more on investing, saving enough, and minimizing investment expenses, read the aforementioned books or subscribe to On Financial Success for free.

Photo by Peter Corbett