Is Your 401(k) Portfolio Too Conservative
If you have a 401(k), you are not alone. This traditional savings vehicle is still one of the more popular methods of investing for the future. Still, even it is pretty popular, it’s easy to make the mistake of not doing your research before choosing the best investments to grow your savings. Best in this case doesn’t necessarily mean just the best-performing funds: It means the best for your specific needs. For example, a conservative approach has its time and place, for sure, but if you’re too conservative at the wrong time, you could hinder your savings progress.
Avoiding Making Mistakes
One of the most significant errors you might make is not taking enough risk. All investments come with risk and the potential “reward” – in this case, financial earnings, is usually commensurate with the level of risk.
It may be tempting to stay on the conservative side to curb your risk, however, if you are too conservative, your portfolio might not grow fast enough or grow enough over time to reach your retirement savings goal. For example, traditional investments include bond funds, while stocks came with their risks. If you invest solely in bonds, you may limit your returns, as bonds do not often have the highest returns.
Suppose you are living on a tight budget and can’t afford to put much into your account. In that case, you might end up losing value on the money over time with a conservative account. If you want your retirement funds to give you better golden years, you’ll need to ensure your money works for you. Adding stocks to the account might help you be more aggressive, which could lead to achieving better growth.
Stocks fluctuate more than bonds in a shorter period, but they can give you a much higher return over time. Over long times, the average return has been around 10 percent. If you are already close to retiring and will need to access your savings in the near future, stocks may not be your best savings vehicle due to their level of risk.
However, if you are younger, you have more years to ride out any market volatility and can often take more risk to get a better return. If you have 10 years or longer, the fluctuations will usually not affect the final amount in your account when it is time to withdraw.
You can use online financial planning and retirement planning software to help you figure out what the best allocation is for you at this stage in life. Two software packages that allow for asset allocation scenarios are WealthTrace and MoneyGuidePro. Note that WealthTrace is designed mainly with consumers in mind while MoneyGuidePro is mainly for advisors, although they do sell to individuals too.
Determining if the Portfolio is Too conservative
One of the best ways of telling if your portfolio is too conservative is that it does not grow over time. For example, if you consistently add a bit from each paycheck but notice that it does not grow over time, you may not be investing the funds appropriately. Consider evaluating it over the long term to determine how much it is growing.
Even looking at it over a year or several months might not be enough perspective. Stocks tend to fluctuate over many years. You’ll also want to avoid considering too deeply the stock market’s short-term effects on the portfolio balance.
Having a Large Allocation to Bond Funds
If the portfolio has a larger allocation to bond funds, it might be too conservative. If you miss out on this growth potential when you are in your younger years, you might not have the best potential for taking advantage of compound interest – the earnings on your earnings – a couple of decades later.
If too much goes toward bonds early on, you may not have the best growth. You will often get less than two percent on most of the available bonds today. They also don’t tend to grow with inflation.
A good rule of thumb is to have less than half of your funds allocated toward bonds. Still, it depends mainly on your age and where you think you would like the funds to go when you retire. Still, not every bond fund is the same, meaning you can often diversify even the amounts you have in your bonds. Some offer low yields that are incredibly safe. With other funds, you’ll need to trade a bit to ensure you take advantage of fluctuations in the pricing to get a better yield.
Fixing Conservative Portfolios
The best way to fix a too-conservative portfolio is to begin trading out some of the bond funds slowly; then you can get stock funds in their place. The amount will depend on the amount of time you have before you need the money.
If you have several decades left, there is plenty of time to take that risk. Over time, you will be rewarded. It is best to be more aggressive during your younger years, and then you can adjust your portfolio to be more conservative when you are older.
Another way to save in a way that is appropriately aggressive or conservative with your years in life is to take advantage of target-date funds as well. This approach lets you save through a professionally built and managed portfolio that rebalances to become more conservative as you age.
The best way to tell if your portfolio is too conservative is to watch your account’s performance over time and to consider your current investments against your years until retirement. Investing in the stock markets is an ideal way of ensuring you have a more diverse portfolio. You do not need to have everything there, but it is still best to have a relatively large portion. That way, the account can grow, giving you enough during retirement. If you are too conservative, your savings might suffer.