How to Choose Your 401(k) Investments

Most people given the opportunity to invest in a 401(k) plan haven't the first clue about what to do. Eyes glaze over and what follows who knows.

Believe it or not, you don't need to be a financial guru to profitably manage a 401(k). You don't even need to care much about investing.

No matter who you are, your task of saving for retirement need not be any more daunting than deciding on what clothes to wear. The fact is, if you can distinguish up from down, then you possess all the knowledge necessary for becoming a whiz managing your 401(k) investments profitably.

Now the question is, which among the many investment alternatives available in a typical 401(k) plan should you choose?

My answer is stick with funds investing 100% in stocks, because history reveals stocks yield superior returns. No matter how much or how little you save, put your money to work in investments likely to give you the most bang for your buck . Stocks are where the money is at.

So, go ahead and determine which among your 401(k)'s investment alternatives will put your savings 100% in stocks. No bonds. Just 100% invested in stocks. You might find anywhere between six and a dozen funds in your 401(k) plan that qualify. While you're at it, get the "ticker symbol" for each fund (you will need this in your effort to manage your investment risk, a simple task requiring no more than five minutes a month).

Now, if you already hate this exercise, let's make it fun. Give each fund investing 100% in stocks a number, starting at one. Now go to a dart board, and start firing until you hit three of the fund numbers. Among those three funds, then, you can evenly split your 401(k) contributions.

No, this is not crazy! You're aiming for diversification in your stock investments. This way you are likely to match the performance of the broad stock market when it is rising, which is the only time you want all of your 401(k) savings invested in stocks.

Those more ambitious might take time to research the funds in their 401(k) plan investing 100% in stocks. You will be aiming for the same effect as those shooting darts. You want diversity. Whatever mix your heart desires will be fine. Growth, value, large-cap, mid-cap, small-cap might be among the terms you see describing each fund investing 100% in stocks. Just pick three and evenly split your contributions.

The main thing is focus your attention only on those alternatives investing 100% in stocks.

Now, this is important: Your periodic 401(k) contributions (weekly, bi-weekly, monthly) always will go into funds investing 100% in stocks, i.e. the funds you choose. In other words, as a matter of practice your regular contributions should be directed into stock investments, no matter what is happening in the stock market. So long as you are employed and contributing to your 401(k), you will never have to change this tactic. Of course, at some point you might decide to alter the specific funds your contributions go to (i.e. among those investing 100% in stocks). That's entirely up to you.

This might seem confusing, but right now, you don't care about the greater risk associated with investing in stocks. Trust me, you can manage this risk like a pro and prevent it from destroying your savings.

In no time at all your position in the stock funds you have chosen—the funds receiving your periodic contributions—will begin building. If history is any guide, you will have begun to see a profit from your investments, as well. You must guard your profits with your life, never assuming they will continue growing without a hiccup. There will come a time when you must act to protect your investment profits and bank your gains.

When you do this, it will be for one reason: SAFETY. Your #1 priority is ensuring the safety of your retirement savings.

Fact: Sometimes stocks become extremely risky and subject to suffering steep losses. Times like these you are better off not risking your entire 401(k) in stocks.

At such times you will transfer your 401(k) investment capital out of the funds 100% invested in stocks and into what's called a "money market fund" (like a bank savings account, but without FDIC insurance). When the stock market is being roiled you want your savings protected. That's what a "money market fund" provides.

So, in addition to funds 100% invested in stocks you also want to identify which among your 401(k)'s investment choices is the safest money market fund. A money market fund investing exclusively in U.S. Treasury Bills is the safest of all.

The money market fund will be your 401(k)'s bodyguard when the risk of suffering unbearable losses investing in stocks becomes too great.

So what we have here are the makings of a 401(k) investment strategy that can be summarized as follows...

• Plan A: Seek superior returns via a diversified position in select funds investing 100% of your money in stocks. Every penny you contribute to your 401(k) will be directed here.


• Plan B: Bank gains and preserve wealth in a safe money market fund. When your risk of suffering a steep loss investing in the stock market becomes elevated, you will park your savings in the safest investment available, a money market fund.

Your part in switching from plan A to plan B and back again is a function of a more or less mechanical effort, where in just a matter of seconds you can know with relative certainty whether opportunity in stocks is knocking or danger demanding capital preservation is the order of the day.

This 401(k) investment strategy—having worked beautifully over the past thirty years—is sure to protect you from ever having to endure devastating losses. With safety being your first priority, you also set yourself up to realize exceptional long-term gains, even surpassing professional money managers.

Granted, this strategy's capacity to deliver superior returns is by no means guaranteed. I'll have more to say on this some other time. Still, balancing your desire to maintain an utmost measure of safety, while otherwise seeking to maximize the profit potential of your retirement savings, this strategy has history on its side.

And you know what they say...

History may not repeat, but it often rhymes.