This post is for average 401(k) investors.? I’m going to let you in on a secret that is not so secret, but does not get talked about much.? It’s a simple idea as well, and would be common sense, if sense were common.
401(k) investors tend not to change their allocations often, except to panic when things are going bad, or arrive late in bull market, and buy near the top.? In general, if you don’t have a lot of investment knowledge, it is good to come to a place where you “set it, and forget it.”? Remember, those with no experience are far more prone to the errors of fear and greed than most experts are.? Those arrive late to a rise or a fall in the market, and say, “Look what I have missed out on,” or ‘Look at how much I have lost,” are going to make the wrong move again and again.
There are temptations as an investor to not diversify.
- “I’ll just hold all my assets in a money market fund.? I don’t want to lose anything.”? Money market funds preserve value at best.? They won’t help you build value.
- “I’ll just hold all my assets in gold.? I don’t want to lose anything.”? Gold preserves value at best.? It won’t help you build value.
- “This manager is the greatest.? I’m putting it all on him.”?? Sadly, managers have hot and cold streaks.? Many people join in near the end of hot streaks.? The quote I heard this from was a professional in 1999, deciding to invest all his money with Bill Miller.? Bad timing.
- “Stocks win in the long run.? I am investing only in stocks.”? If you have a really long time horizon, and you are certain that your nation will not go through a revolution, or something close to it, that will work.? Otherwise, you are taking a risk.
There are more, but I think you get the point.? In most of life, those who do the best are the ones that take prudent risks.? Prudent risks are where the likely rewards outweighs the likely risks.
Think of it: in business, the guy who never takes risk does not do well.? The guy who takes huge risks blows up frequently, and does not do well on average.? The guy who takes moderate, prudent risks tends to do well.
The same is true of bond investing.? Those who invest in bonds of medium risk (BBB/Baa) tend to do best, those that play it safe or risk it all do less well.
The same is true of stock investing.? Stock investing is risky by nature, and in general, those who take less risk tend to earn better returns over time.? Ignore the canard: more risk, more return.? It ain’t so.
So what would I do if I were a 401(k) investor facing a limited menu of choices?
- Put 60-70% in conservative, value-oriented stock funds. (US and Foreign)
- And 25-35% in moderately risky bond funds. (US and Foreign)
- And 5% in cash.
- And rebalance yearly.? Do it after you complete your taxes, or something like that.
Avoid complexity.? Even if the plan offers a wide number of choices, winnow it down to a few funds, say five at most.? Over the long run, your investments should prosper, because you are doing things that few investors will do, and enjoy? returns from bearing risk successfully.
For the average 401K investor, the 401K is his retirement plan. It seems to me that the purpose of his portfolio should be to guarantee the minimum level of income he will need if he lives to be 100. This portfolio does not do that. It’s a reasonable portfolio for someone who desires to make money outside of his 401K, assuming he has such money, which most Americans don’t. TIPS or TIP funds, which are found increasingly in menu choices (and probably should be mandated by law as a choice) are the only appropriate choice for most investors in my opinion. If not that, cash, or short term gov guaranteed bonds.
@mGk: it might be true that their 401k is the main retirement plan for most people, but most people are not yet retired. Your comment makes sense for someone retiring now, but does not for a mid-career saver who is actively contributing and has 20-30 years until retirement. Which was DM’s audience.
You would suggest a 40 y.o. have a portfolio of TIPs, T-bills and cash? I’m financially conservative, but that is nuts.
@SteveHamlin:
If it were a sure thing that David’s portfolio would meet a person’s minimum needs in retirement over the long run (or any relevant time period), I would agree with you. Unfortunately, a 60-70% equity portfolio is not guaranteed to do that. Even if it had a 95% chance of doing so, if the minimum need really is the minimum, it seems to me that any sane person would want to guarantee it, since the alternative is a 5% chance of being impoverished at age 78. Only TIPS can make that guarantee. In the USA, we have built an entire 401K retirement system that substitutes magical thinking for real savings and real security. Where I do agree with you is once you are sure that your minimum needs in retirement will be met, whether through Social Security or your other assets, David’s portfolio makes sense. However, insofar as it is addressed to people under the age of 40, very few of whom have saved enough to guarantee their minimum needs in retirement, it strikes me as a form of magical thinking based on equity returns that may never materialize. People need to be told that they should be saving more, not that if they allocate 65% to stocks, they are being prudent. And I say this with great respect and a bit of trepidation, because David is da’ Man IMO.