How to invest in 401(k)

If your company offers you a 401(k) match, you should absolutely take advantage of that offering and start saving for future, plus receiving tax benefits at the same time. But if the funds are limited, only 10 or a dozen investment funds to choose from, or 20-30, 30-40, how do you pick and choose? How do you build a diverse 401(k) portfolio?

If you invest more than 20% of your retirement savings in any one company or industry, your savings may not be properly diversified. Although diversification is not a guarantee against loss, it is an effective strategy to help you manage investment risk.

There are 2 factors that you should look at:

Short-Term and Long-Term Returns (3 month, 6 month, 1 year, 3 year, 5 year, 10 year or since inception)
Expense Ratio (cost or fees to hold the fund for a year, usually it’s a % of the dollar invested)

You should always sort out the funds by return and fees, try to find the highest return with the lowest amount of fees. Some funds look attractive in short-term, yielding a high return, but in long run, it generates lower returns than others. Usually, there is a list of Target-Date funds, this can be the targeted year for retirement. Your company may by default put your funds in there. In this type of funds, it has a lower fee and does all the diversification for you. However, these may have less return than other high-fee and more volatile funds. If you are closer to your retirement age, these will be safety net for you. If you are early in your career, and you are looking manage the portfolio and balance it yourself, you will want to have a look at the the other funds available in your 401(k) list and the large, mid, small blend/growth/value funds vary greatly in terms of risk and returns.

To help achieve long-term retirement security, you should give careful consideration to the benefits of a well-balanced and diversified investment portfolio. Spreading your assets among different types of investments can help you achieve a favorable rate of return, while minimizing your overall risk of losing money. This is because market or other economic conditions that cause one category of assets, or one particular security, to perform very well often cause another asset category, or another particular security, to perform poorly.

Follow these principles will help you build your portfolio smartly:
1. Consider diversification: Diversification is the key to minimize risk and help you achieving long-term goals.

2. Know your risk tolerance level: Is it high, medium or low. Avoid taking too much risk or too conservative. You will want a portfolio that grows in years to come and be able to sleep at night.

3. Rebalance: Either once a year or twice a year, review your portfolio and know how much time you have left until you need to withdraw the money. Re-evaluate the fund performance and adjust if necessary. This way your distribution will not get out of alignment from where you started.

List of funds in a 401(k):

Stock Mutual Funds (Large/Mid/Small Value/Growth/Blend stocks): They can be dividend stocks. One option many love is S&P 500 index fund, which includes the largest American companies.

Target-date Mutual Funds: These funds (2020 to 2070) invest in both stocks and bonds, and because they allocate to each category based on the year participants plan to retire, that is why they have the targeted retirement date in their names.

Stable value funds: These are very stable but low return funds. They are the safe bets, for example: government medium term bonds. They are more attractive to folks that are closer to retirement age.

Bond mutual funds: They invest only in bonds (short-term bonds, intermediate-bonds), government bonds, etc.

Some 401(k) also allow you to buy individual stocks, ETFs or other mutual funds. This plan give you the option to manage it yourself. This is more appropriate to advanced investors.