Company-sponsored 401(k) plans are one of the best ways to invest for retirement. To get the most out of your 401(k), you need to educate yourself on the basics of retirement savings. To help you choose the best investments for your savings goals, it is critical to understand three of the core components of financial planning: risk tolerance, time horizon and asset allocation.
Risk Tolerance
Risk tolerance is widely used as a measure to determine how much risk an individual can withstand. In terms of retirement savings, risk tolerance is a determination of how much money an individual can stand to lose in relation to how much time that individual has to recover from any losses. In general, younger investors are considered to have higher levels of risk tolerance. Although age is one of the stronger variables considered in risk assessment, other factors also play a role. Family size, income level, credit history and more all factor in risk tolerance assessments. Understanding your level of risk tolerance will help determine how much risk to take when choosing funds for your 401(k).
Time Horizon
Time horizon, also known as investment horizon, is the amount of time an investment is expected to be held before the funds are liquidated. As with risk tolerance, age again weighs heavily in this calculation. Younger investors have more time to let their investments grow before they reach retirement age. For retirement savings, the time horizon determines how much time your funds have to grow in any given investment before you start to take distributions. Knowing how long you have to keep funds locked into an investment will guide your decision on which investment options best suit your situation.
Asset Allocation
Once you have determined your risk tolerance and time horizon, you can use those factors to guide your asset allocation decisions. Investors with low risk tolerance and a short time horizon generally favor a conservative investment strategy. Investors with high risk tolerance combined with a long time horizon often choose a more aggressive investment strategy. For those who fall somewhere in the middle, a combination of conservative and aggressive investments makes the most sense.
Choosing Your Investment Portfolio
Investment options vary from one 401(k) plan to another. Your 401(k) plan administrator will provide you with documentation detailing all the funds available for you to choose. The level of detail varies from provider to provider, but in most cases, you can determine which funds are considered conservative and which are more aggressive for investors. Knowing your risk tolerance, time horizon and asset allocation strategy will guide with your selection process.
Many 401(k) plan providers have simplified investment options by offering target-date funds or other packaged investment options. Target-date funds, for example, use your target retirement age to select funds to help maximize your savings. These types of pre-packaged portfolios are great for individuals who want a more hands-off approach to retirement planning.
Our team of investment advisors at Wickham Financial & Insurance Services works closely with clients at every level of the career spectrum. We will help you evaluate your risk tolerance, determine your time horizon and guide you through your asset allocation decisions. Customizing your 401(k) investments as much as possible ensures that you maximize your savings for your future. Let us help you choose the best investments to meet your retirement savings goals.
Any information provided has been prepared from sources believed to be reliable but is not guaranteed, does not represent all available data necessary for making investment decisions and is for informational purposes only.