401k plans have become one of the most popular retirement savings vehicles for American workers. They offer convenient payroll deductions, tax-deferred growth, and a menu of investment options to meet different goals and risk tolerances. While the specific funds offered in 401k plans vary by employer, most contain a core set of basic investment types that make up the foundation of a diversified portfolio. In this article, we will briefly summarize five of the most common investment categories found in 401k plans and their key characteristics.
Stock index funds provide broad market exposure
Stock index funds like the S&P 500 index are core holdings in many 401k plans. They offer instant diversification by investing in hundreds of large US companies in a single fund. Returns largely track the overall stock market. While index funds carry market risk, they provide key equity exposure for long-term growth potential. Many plans offer US and international stock index funds covering developed and emerging markets.
Target date funds simplify investing for retirement timelines
Target date funds provide an all-in-one set-it-and-forget-it approach to 401k investing. You simply pick a fund near your estimated retirement year, such as a 2040 or 2050 fund. The fund automatically adjusts its asset allocation over time, gradually reducing market risks as you approach retirement. Target date funds take the guesswork out of maintaining proper asset allocation.
Bonds and stable value funds reduce volatility
Adding some bond exposure helps manage the volatility of an all-stock portfolio. Many 401k plans offer core US bond index funds as well as stable value funds that aim to preserve principal while earning interest income. The percent of fixed-income assets you hold depends on your risk tolerance and time horizon. Retirees may allocate more heavily to bonds and cash equivalents to generate retirement income.
Company stock delivers focused exposure
Some 401k plans offer the option to invest in company stock. This delivers concentrated exposure to a single investment tied to your employer. While this aligns your financial interests with the company’s performance, it also concentrates risks. Most experts recommend limiting any single stock position to 10% or less of your 401k balance.
Specialty funds provide tactical opportunities
Beyond the core lineup, some 401k plans include tactical investment funds focusing on specific sectors, regions, or alternative assets. These can include real estate, commodities, emerging markets, and more. Specialty funds help round out a 401k portfolio and diversify into additional market exposures. However, they should represent smaller satellite positions around a core index fund allocation.
401k plans offer an array of investment options to construct a diversified portfolio suited to your goals, timeline, and risk tolerance. Focus first on allocating appropriately between stocks and bonds, then complement with specialty funds in smaller amounts to enhance diversity and return potential. Rebalance your 401k regularly to maintain your target asset allocation over time.