Your 401k Shouldn't Be in a Casino

Saturday, August 11, 2012

Your 401k Shouldn't Be in a Casino

The 401(k) savings account is the foundation for most people's retirement financial security. Investors, who have 401(k) heavily skewed towards individual stocks, risk their assets violently whipsawed by the Wall Street casino.  The ever present risk of a crash, similar to 2008, can have dire consequences for a stock portfolio heavily weighted towards stocks.  In fact, for the ten years time period from December 2000 through December 2010, the S&P 500 Index actually lost 4.7%.  Here are several alternative investment vehicles that can assist 401(k) investors in constructing a more balanced, diversified portfolio. 

Savings Bond 

Savings bonds are debt commitments to pay for the country's borrowing requirements.  The yields are nothing special in today's low interest rate environment; however they do offer the guarantee of return, based upon the credit of the government.

Stock Mutual Funds 

Many investors simply aren't comfortable doing their own security analysis and stock selection.  Stock mutual funds are professionally managed vehicles that invest pools of funds from a large number of investors.  There are many different types of stock mutual funds, including small cap versus large cap, value versus growth, and specific funds for individual sectors such as health care and technology.  For long term 401(k) investors, look for funds that are broad based in nature and offer low fees.  Index mutual funds, which attempt to track specific stock indices, often offer the lowest fees and provide excellent diversification.

Bond Mutual Funds 

Bond mutual funds invest in bonds and other debt related instruments.  These funds can help provide a critical income stream and diversification to a 401(k) portfolio.  Typically, it is difficult for an individual investor to construct a portfolio of individual debt securities due to the high transaction costs and relative illiquidity of many segments of the bond market.  While bonds typically do not offer the upside potential of equity investments, they are considered safer investments that have a lower potential for capital losses.  However, they are subject to interest rate and credit risks.  

A rise in interest rates will depress the Net Asset Value (NAV) of a bond mutual fund's holdings.  Credit risk is spread among literally hundreds of different securities so the potential for a blow up is minimal versus an individual bond portfolio.  Bond funds fall into three general categories, corporate, municipal, and government.  Corporate bond funds have different levels of risks based upon their perceived financial stability, while the U.S. Government bond funds are considered the safest from a credit risk standpoint.

Go International 

Often 401(k) investors are too U.S. centric in their portfolio composition and overlook the opportunity to invest in international stock and bond mutual funds.  Emerging markets usually sport 4-5% growth rates that exceed those of developed countries.  Demographics are also on their side as they have generally younger populations that are moving into the middle class, with a corresponding increase in purchasing power.  Emerging market government debt funds should also be considered as these countries typically have lower debt-GDP ratios versus developed nations.

While it may seem glamorous for investors to make their own individual stock selections for their 401(k), remember you're going up against some formidable competitors.  Make sure your portfolio is appropriately diversified to ensure your retirement savings can support you for the long haul.    


 This article was written by Karl Stockton. He offers information on retirement savings and payday loans.

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