How should I allocate my 401k? Follow this best 3-step guide

9:00 am · 4 min read

Here are the three strategies how I allocate my retirement account and call it a day.

The inevitable question when planning for retirement, “how should I allocate my 401k?”

I remember doing my research and getting blasted with so much information that I was completely overwhelmed. “Consider your age, your risk tolerance, your options, when you want to retire, etc…”

All too much.

The good news is that at the end of the day, all experts gravitate toward these three strategies, and they each fit a different investor profile.

  1. Start simple with one investment fund choice that does all the work for you.
  2. For more control over allocation, we can build a mix of two funds.
  3. Get even more involved by adding more investments to correct for any excessive risk exposures.

Step #1 – Build a Foundation with Target-Date Funds

Even if your 401k has pretty limited investment options, it will probably have a few target-date funds.

How should I allocate my 401k? With Target-Date Funds.

These are the most no-brainer, simple way to define your 401k and suitable for 99% of investors out there.

Target-Date Funds tick all the boxes regarding a good 401k asset allocation strategy:

  • Takes your age into consideration for risk analysis.
  • Are broadly diversified.
  • Go through frequent rebalancing.

For most people, target-date funds will do the job. Go to your 401k plan, pick the date you’re targeting for retirement, and you’re done with it. It can’t get any simpler than that.

This is the strategy that Ramit Sethi, bestseller author of “I Will Teach You To Be Rich”, advocates. See 401(k): The single best way to grow your money.

So if you’re reaching 59 1/2 – the age you can start withdrawing the money – in 2042, you’d pick the “Target Retirement  2040” fund and that’s it!

Step #2 – Control your allocation

While Target-Date Funds sounds great, some investors love to get a bit more deep into their options (myself included).

Whether because target funds usually demand higher expense ratio or the lack of control over your own allocation, investors can ditch them and choose a more hands-on strategy.

It doesn’t need to be messy or too technical, though. We can start simple with this 2-funds, Stock v.s. Bonds strategy and have plenty of allocation control.

How should I allocate my 401k? With Stocks V.S. Bonds.

  • Pick one fund from the stock market and/or one from bonds.
  • Choose how much to allocate for each fund.
  • Rebalance your portfolio every quarter or yearly.

The goal is to keep it real simple and don’t try to beat the market, just be the market.

To make things work, we need to pick funds that track the broader market. Search for keywords such as Index Funds and Total Market. They generally have a low expense ratio < 0.5%, which is great!

  • Pick total market funds that are diversified.
  • You’ll have to define your allocation yourself.
  • Rebalance your portfolio.

As I mention, that’s the strategy I use. I’m past target date funds because the option I have available is still overly exposed to bonds to my taste.

I have a high-risk tolerance and want to be 100% invested in equities at this point. Right now I have 100% Fidelity® Total Market Index Fund (FSTVX). It has tracked the S&P 500 index very closely for the last 10 years.

Some people might say my allocation is overly concentrated in domestic stocks, and I do agree. That’s why I’m looking to step it up to the next level.

Step #3 – Control your funds

If you want to go one step further, and your 401k allows you more options, you can build your own basket of funds.

How should I allocate my 401k? With a mix of index funds.

So instead of taking a simplistic X% for one stocks fund and Y% for one bonds funds, you can mix more investments.

  • Mix small-caps, mid-cap, large-cap.
  • Mix domestic vs. international.
  • Add alternative funds, such as gold or real estate.

I wouldn’t go further than that. Even if you can pick individual stocks, I’d suggest you don’t. Picking stocks is a bad idea.

With so many index funds that track the market, have low fees and high diversification, it makes little sense to pick stocks for your 401k.

How should I allocate my 401k?

I first started my 401k with a target fund. They are cheap and completely hands-off.

As I learned more about index funds and started growing the taste for finances, I shifted to the second approach. Still very hands-off but with some control.

Now I’m looking to step up the game and correcting my high exposure in domestic stocks by adding international funds and some alternatives.

The bottom-line is: there’s something for everyone here.

No matter where you are in your 401k asset allocation, don’t get stuck in analysis paralysis. Time is only your ally if you take action and put your money to work.

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