3 ways to know if your 401(k) is too aggressive | Economy

June 12, 2021

A 401(k) retirement plan is one of the most popular ways to save money for retirement and score some tax breaks for doing so. But often these plans don’t provide a lot of guidance on how to manage them, and participants end up with wildly aggressive portfolios, or, what experts often see, a portfolio so conservative that it barely budges year after year.

Here’s how to see if your 401(k) is too aggressive and, if so, some steps you can take to fix it:

When experts speak of being aggressive, they generally mean how much of your assets are in stocks or stock funds. Stocks are an attractive long-term investment, but they fluctuate a lot in the short term. That’s problematic, especially for soon-to-retire investors. If all or almost all of your retirement account is in stocks or stock funds, it’s aggressive.

While being more aggressive can make a lot of sense if you have five or 10 years or more until retirement, it can really sink you financially if you need the money in less than five years. To reduce risk, investors can add more bond funds to their portfolio or even hold some CDs.

“A large downturn in the market immediately preceding retirement can have devastating effects on an individual’s standard of living in retirement,” says Dr. Robert Johnson, finance professor at Creighton University’s Heider College of Business.

Johnson points to those who retired at the end of 2008 and who were invested only in the Standard & Poor’s 500 Index (S&P 500), which contains hundreds of top companies. “If they were invested in the S&P 500, they would have seen their assets fall by 37 percent in one year,” he says.

But those who had some investments in other assets such as bonds or even cash would have seen a much lower overall decline. Of course, any money in the S&P 500 would have declined by a similar amount, but by having fewer eggs in that basket, their overall portfolio declined less.

That principle of diversification is huge in making sure that your portfolio is not too aggressive.

But many workers make the opposite mistake, not investing aggressively enough. If you have more than five years until retirement, and certainly if you have 10 or more, you can afford to be more aggressive, because you have the time to ride out the market’s ups and downs.

If you think your portfolio might be too aggressive, here are some signs to look for:

Your account balance fluctuates a lot. It can be exciting to see your balance run up quickly, but it’s important to realize that this could be an effect of a 401(k) that’s invested too heavily in stock funds and not enough in safer alternatives.

“If you take someone with an account balance of $100,000 and after one month their account is now $110,000, or 10 percent growth in a month, what that tells me is that they probably have most of their money in stocks,” says Matthew Trujillo, CFP at Center for Financial Planning in Southfield, Mich.

“This will feel great when things are going up, but that investor needs to be prepared to see some significant paper losses when we experience a downturn like what we just saw in March and April,” says Trujillo.

You worry a lot about your 401(k). If downturns in your 401(k) cause you a lot of worry, then you may be investing too aggressively.

“If someone tends to move out of their investments because of volatility, then the portfolio is probably too aggressive for them,” says Randy Carver, president and CEO at Carver Financial Services in the Cleveland area.

But it’s key to understand that while stocks are more volatile and you may not always feel comfortable owning them, they are also one of the best ways to grow your wealth over time, especially in an era of low interest rates and low bond yields.

“If they are not invested to grow enough to meet long-term needs, it is too conservative,” says Trujillo. “The key is to look at longer periods of time, two or three years or more, to see trends, not just one or two months.”

You need cash soon, but your 401(k) doesn’t have any.

If you know you’re going to need cash in the next few years, your 401(k) needs to be factoring that in. That doesn’t mean you need to sell everything and go to cash now, but you can leave new contributions in cash or move them into lower-risk bond funds, slowly reducing aggressiveness.

To gauge your plan’s aggressiveness, use the rule of 100, suggests Chris Keller, partner at Kingman Financial Group in San Antonio. With this rule, you subtract your age from 100 to find your allocation to stock funds. For example, a 30-year-old would put 70 percent of a 401(k) in stocks. Naturally, this rule moves the 401(k) to become less risky as you approach retirement.

Pointing to the importance of a 70-year-old reducing risk, Keller says, “Losing half of your portfolio while at this age might have a huge impact on what your retirement looks like.”

Having a 401(k) portfolio that’s too aggressive can come with a number of disadvantages, from the annoying to the financially destructive. Here are some of the most common:

Your wealth fluctuates a lot. If you’re overexposed to stocks, your portfolio will bounce around more than it will with less exposure. That can be OK if you have a long time until retirement, but it’s potentially much more costly if you’re close to retirement.

You may need to access your money when the market’s down. If you’re too aggressive with only a few years or less until retirement, you’re wagering that the market will stay strong until you tap your money. If it doesn’t, you’ll have to take distributions in a down market, hurting your long-term retirement finances.

A too-aggressive portfolio may scare you out of the market. The secret to scoring big returns in the market is staying invested. So if a volatile portfolio scares you out of the market, you lose the key advantage of investing in stocks.

Less diversification may mean higher risk. A diversified stock portfolio can be useful, but if you’re in all stocks, your overall portfolio may not be as diversified as it could be. So if something negatively impacts stocks as a whole, your diversification among stocks won’t help you.

If your portfolio is all stock, then you might not generate much cash. A portfolio with some bonds or CDs can produce cash, helping you weather a downturn or allowing you to stay invested in stocks, which usually show better long-term returns.