Maximizing Returns and Minimizing Risk in a Conservative 401(k) Plan

Creating a Conservative 401(k) Plan

A conservative 401(k) focuses on protecting the capital you’ve already saved, which is a smart strategy for those nearing retirement. A financial advisor can help you create a plan to fit your goals and investment needs.

A low-risk portfolio may feel safe, but it will stifle long-term growth and leave you exposed to inflation. Instead, try to find ways to boost your long-term returns.

1. Asset Allocation

Investing in asset allocation, or spreading out your money among various classes of investments, is essential to conservative 401k plans. It helps reduce risk because stocks (also known as equities) are the riskiest way to invest, while bonds and other fixed-income investments offer lower risk.

The exact asset allocation you choose depends on your anticipated retirement timeline and your own personal risk tolerance. If you plan to retire in 30 years, for example, you still have plenty of time to ride out short-term market fluctuations without having to tap your accounts early. You can use a target-date fund that manages your portfolio’s allocation and moves you toward a more conservative allocation as you approach retirement, but it is important to understand these funds don’t guarantee a profit or protect against loss.

A more advanced option is a risk-based balanced mutual fund that invests across many asset classes and aligns with your stated investment risk. These funds also rebalance automatically and you can adjust your allocation as your life changes.

2. Money Market Funds

As the name suggests, money market funds are a safe and stable way to earn a little bit of interest on your cash. These funds can provide you with the liquidity that you may need to access your account in a hurry, such as for a large purchase.

However, their yields can be very low as the funds typically invest in short duration securities like certificates of deposit (CDs), Treasury bills and short-term commercial paper. As a result, their sensitivity to interest rate risk is limited.

The financial crisis of 2008 prompted the Securities and Exchange Commission to closely examine the rules of money market funds. As a consequence, some of the largest and oldest money market funds “broke the buck,” meaning that their NAVs dropped below $1.

The new money market fund rules have loosened up the ability of some funds to impose fees or gates when they think that investors are selling their shares too quickly.

3. Annuities

Putting a chunk of your retirement savings in an immediate or deferred fixed annuity can help you generate a steady stream of income. In addition, you can typically arrange to leave some or all of the principal to heirs.

But most 401(k) plan investors aren’t even aware of the option, says Nick Nefouse, BlackRock’s managing director for the target-date fund franchise. And if they do know about it, they often don’t pursue the strategy because of its cost.

For instance, a 65-year-old who invests $100,000 in an immediate annuity could expect to receive just $486 per month for life, according to Schwab’s annuity calculator. And that payment would never be adjusted for inflation. Moreover, the principal he pays upfront will get taxed once he starts receiving it. By contrast, his index fund would earn the same amount but that money wouldn’t be taxed until he withdraws it. The tax advantage may be enough to sway some investors to give the annuity strategy a second look.

4. Stock Funds

401(k) plans usually offer a limited selection of mutual funds and exchange-traded funds (ETFs). Typically, you can’t invest directly in individual stocks or bonds. Instead, you buy shares in a fund that holds many securities or an ETF.

Some conservative 401(k) investors favor bond funds, which typically earn little or no return. PGIM Total Return Bond, for example, has a low current yield of 3.0%. That fund invests in investment-grade corporate bonds and short-maturity Treasuries.

Investors who prefer a higher level of growth should consider using stock funds. While these investments may fluctuate more in the short term, they tend to deliver more than bond funds over long periods of time. A recession, however, can hurt asset prices and reduce your 401(k) balance.

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