Thursday, August 5, 2010

What to Do With 401k Allocation Choices

A good friend from Kellogg asked me to help her with her 401k Allocation choices. I'm not a pro, but tried to give her some general guidance. After I wrote the email, I figured I might as well post it here so others could either point out the flaws or use it themselves if they think it's a good framework. Remember, I'm not a pro.

General rules - 

1) Diversification is very important. Will protect you over the long haul. some things go down, some go up. the nice thing about a 401k and automatic contribution is that when things are going down, you are still buying them, so you are dollar cost averaging down. You may want to set up something where you re-balance every year. That way you take profits on things that have gone up, and dollar cost average down even more. I don't really worry about that, but that is me. I'm lazy and I figure my time frame is so long that it's not a huge deal.

2) My friend is 30 so so she is still very young, so you want to take some risk. If you were 50, I'd say have a lot of your money in more conservative things like a lot of bonds and large cap. You should have some exposure to International stocks and bonds, which are riskier but theoretically have a higher return profile, as well as Alternatives like Real Estate and Natural Resources.

There are two ways to do this with her choices, pick funds that are a complete diversification plays (different securities and different asset classes) within themselves. A general Capital Appreciation Fund is like that. You can put a lot of money into that and know you have some diversifcation. Find a general bond fund like that, and you are good. Probably 80% to 20%.

Personally, I like diversification on the funds too, that way, no one bad fund performance can screw me up too bad. Therefore, I allocate based on Asset Classes and just try to pick the best ones based on expense ratio and I look at performance too, but past performance is no guarantee of future success.

Using my strategy, I break up allocations into Asset Classes. My 401k allocation is about the percentages below. This would be my rec, but you can't really go wrong as long as you are diversified. Also, I'm not a pro so take mine with a grain of salt.

US Big Cap - 20%
US Small Cap (or Mid Cap) - 15%
Value Fund - 10%
US Bond (or High Quality US & Euro Bond) - 10%
Global Equity - 15%
Global Bond - 15%
Real Estate - 7.5%
Natural Resources - 7.5%

Hope this helps everyone. Please point out the flaws in my thinking in the comments!