Choosing the Right Investments in Your 401k - How to Manage Your 401k Like a Pro Part 2

hey what's up everyone and welcome to the school of personal finance in this week's video we're going to do part two of how to manage your 401k plan like a pro in part one we talked about if you should contribute to your 401k or your 403b if so how much should you contribute and also if you should choose traditional versus Roth in your 401k or 403b plan in this video we're going to talk about asset allocation risk tolerance how to find the right mix for you growth over the long term how to choose which funds inside of your 401k plan what to look out for how often you should make changes in your 401k plan and the overall management of the Investment Portfolio I hope that you find this one helpful all right let's get to it all right so let's start out by talking about risk tolerance so now none of this is personal financial advice I don't know anything about you this is all for just educational purposes only but when we talk about risk tolerance we're talking about how much risk are you willing to take where you're still able to sleep well at night where you're not going to going to panic and say get me out of all this stuff I can't take the pain anymore because as we know investing in anything that is geared towards growth is going to be like going on a roller coaster ride you're going to have good years and you're going to have bad years but if we zoom out and we look at a long-term history of investing in the stock market it has done very well so much better than investing in just savings accounts or treasury bonds but the ride has been much bumpier so if you have a long-term time Horizon meaning you have 30 40 20 plus years before you're going to be using this money then history has taught us that investing in stocks that is where you're going to get the most growth but you have to be comfortable you can't panic when things go against you so I always tell people to look at downturns in the market as opportunities to add money at lower prices if we go back and look at some of the worst years in stock market history we'll see that they really were a great opportunity to be adding money and the easiest way to continuously add money is through payroll deduction in your 401k or your 403b or your 457 plan like if we look at 1987 which was Black Monday where the market dropped and people were jumping out of Windows if we look at you know the tech bubble bursting in 20002 2001 the Great Recession 2008 2009 even covid in 2020 last year was not a great year 2022 was a pretty miserable year for the stock market but all those years when you zoom out and you look at a long-term chart they were all just great times to be continuously adding money to your retirement accounts so now nothing is guaranteed right so we don't know what the Market's going to do in the future we could put together a decade of no growth that did happen from the year 2000 basically to the year 2010 because we had that Doom bubble and the Great Recession where we basically had 10 years of no growth but we've been going up ever since then now as you approach retirement and your time Horizon is shorter then yes you want to change your asset allocation because you want to make sure that your money is safe and secure for the years that you need to withdraw it but it's not like like you enter retirement and you need all your money to be safe and secure because you don't take it all out at that point it still needs to last you another 30 40 years depending on how long you live so you still need to have a portion of it invested for growth but for the years right when you retire if you know that you're going to be withdrawing say $50,000 a year from your retirement account then that money you want to have it safe and secure so that you know it's there all right so let's talk about asset allocation right and all we mean when we say asset allocation is the percentage of stocks versus bonds and then even underneath those right with stocks there's many different types of stocks that you could invest in you could invest in large cap growth big companies like Microsoft and Apple and Google and Amazon midsize companies small cap companies that you probably have never heard of international companies Emerging Market companies there's all these different stocks that you could invest in inside of your portfolio and with bonds it's the same thing there's many different types of bonds you can invest in short-term bonds midterm bonds long-term bonds and they each have a place in somebody portfolio depending on their risk tolerance and their time Horizon so we're going to talk about how to actually put together an asset allocation for you depending on what stage of life that you're in and now one thing that is so important to the overall performance of your retirement account is the fee structure and the expense ratios in the funds that you choose so one thing that you want to look at when you're looking at the different options you have available inside of your plan is how much does it cost to invest in a certain fund and some funds are what we call passive and some are active and the difference is a passive fund is going to follow an index so like the US stock market index like an S&P 500 fund if you turn on CNBC you'll see how the S&P 500 is doing and if you could buy an S&P 500 Index Fund then it's just going to follow what the S&P 500 is doing and that will have a very low expense ratio hopefully inside of your 401k plan the opposite of that is an actively managed fund where maybe it's through a big brokerage house like JP Morgan right active active growth fund where they are going to pick and choose stocks that they think are going to outperform the market for growth and to have an active fund manager it costs more to invest in those types of funds now again this is not investment advice but I'd like to go with passive funds so you know exactly what you're getting you're following an index and it keeps the expense ratio very low history has also taught us that active fund managers they typically do not beat the indexes so you are better off going with these lowcost index funds and just letting it ride setting it and forgetting it over a long period of time all right so now that you go through and you look at the expense ratios next you want to think about how aggressive do I want to be what kind of portfolio do I want to have and again my opinion not investment advice if you are in your 20s or in your 30s then I really do believe you could be 95% to 100% invested in the stock market so let's say that is you and you're going to have 100% of your money invested in the stock market out of that 100% you want to divy it up between large cap companies midcap companies small cap companies International companies Emerging Market companies and a typical allocation might be to have 50% in the S&P 500 Index Fund which are larger companies to have 15% in a midcap fund hopefully a midcap blend fund where you get value companies and growth in One Fund maybe have 15% in a small Cap Fund a mix small cap value small cap growth right so right there you have 80% % of your allocation in the US Stock Market and then maybe 10% in Emerging Market funds right in countries all over the world that are emerging and then to have 10% in international established companies as well and that would give you 100% of your portfolio 100% asset allocation now that would be a growth oriented portfolio so you're going to have years where you might be down 30% 40% and you have to be okay with that and look at it like an opportunity for growth now now once you get into your 40s your 50s maybe you want to start thinking about having Bonds in your portfolio or having fixed income and you might add a total bond market fund where it has a combination of short-term bonds midterm bonds long-term bonds some International bonds as well and the percentage is it's going to depend on your asset allocation so at the time of making this I'm 45 years old and I am still pretty much 100% stocks in my retirement accounts CU I have a long-term time Horizon but I have started to think about adding some bond funds in there as well maybe for 5 or 10% of My overall portfolio because it will smooth out the ride a little bit all right so it does come down to your preference and what you're going to be able to sleep well at night having in your account and as you get into your 50s and especially into your 60s you want to start smoothing out the ride and having money that you're earmarking for when you do retire so that by the time you retire maybe you're going to have the next five years of withdrawals that you're going to take in short-term fixed income or money market accounts where you know that you're not going to be losing money the money will be there as you start taking monthly distributions from it all right so now what type of fund that you've probably heard of is what's called Target date retirement funds and these have become very popular all right the theory behind it is that you could just set it and forget it it's the only fund that you need to invest in inside of your 401k and you pick a date that coincides with when you're going to be retiring so for example if you think you're going to be retiring in the year 2050 and you just choose the 2050 Target date retirement fund and the allocation it is going to be aggressive right because you still have over 25 years before you're going to be retiring but there will be some Bonds in there and as you get closer to the retirement date it gets more conservative automatically it's set it and forget it you don't have to do anything the company that manages that Target date fund they automatically will do it for you so there's no stress to it you don't have to worry about it you don't have to rebalance you don't have to do anything it's really set it and for get it which is great but a few things to look out for the expense ratio is usually higher than if you put the funds together yourself so you pay a premium to have this company manage it for you above that sometimes you might not agree with the allocation so you want to see what's under the hood like for example in some of these Target date retirement funds they might have more Bond exposure and more international bond exposure than maybe you want to have in your portfolio so you want to see and understand what makes up that Target date retirement fund another misconception with Target date retirement funds is that it will be 100% safe on the day that you retire and that's not the way it works because the day you retire like I said before you're not pulling the money out all at once it still needs some growth so a lot of Target date retirement funds it might be an asset allocation of 50/50 50% stock 50% bond funds when you reach that Target date but you want to see what that looks like for the Target date that you're investing in so if you like the idea of having said it and forget it not having to worry about it and you you're willing to pay a little bit more to have that then I do think target date retirement funds are a great way to go but now if you'd rather pick your own funds and try to reduce the cost reduce that expense ratio then obviously I'm also a fan of that as well all right so now let's talk about when to make changes in your 401k so if you use a Target date retirement fund then you really don't need to do anything it really is set it and forget it right you might see you'll have some up years some down years but you don't need to change anything inside of the allocation because the company that manages that Target date retirement funds they are going to tweak it for you as you get closer to the Target retirement date they will make it more conservative they will move more into bonds and some out of stocks but now if you're picking your own funds and putting your own portfolio together then you can rebalance when things get a little bit out of whack so for example if large cap growth companies have done really well like they have the last few years you could take a little bit off and rebalance and move that into maybe small and midcap companies which haven't done as well so it's great to start with a Target allocation and then you see as time goes on if you have what we call drift if you have a portion of your allocation that has done better and has grown to a higher percentage than what you want then you sell off some of that and you add it to the things that have not done so well we call this rebalancing it is typically a bad idea and very risky to go in and make changes based on past performance so if you say to yourself you know what large cap growth did awesome last year I want to put all my money there this year that is usually a mistake and nobody knows what's going to happen in the future it's very hard to time the market all right everyone that is it for today I hope that you found this helpful I am going to make a third video in this 401K series talking about loans hardships taking withdrawals from it rolling over your 401k to an IRA when you have a qualifying event so we'll talk about it in the next video thanks for being here I'll see you in the next one