How to Invest Your 401(k): Best Practices

If the company you work for offers a 401(k) savings plan in your benefits package and you’re ready to start watching your nest egg grow, it’s an exciting time for you. At Ark7 we focus on real estate investing, but we also respect the strategy of diversification which is why you can also invest your 401(k) or IRA on Ark7.

However, before you get started, you’ll want to know how to invest your 401(k).

Your 401(k) will offer one or a combination of the following fund options to invest in:

Mutual funds

Mutual funds are the most common offering for a 401(k) and comprise money provided by a group of investors. In turn, that money is invested in stocks, bonds, money markets, and other financial resources. The major benefit for you is that the mutual funds you’re investing in are managed by professional financial managers whose goal is to produce the best return on investments through capital gains. The specifics of what the best return on investment means in a certain fund will be laid out in its prospectus, which you should have access to as an investor. Over time, the fund managers will adjust the fund’s portfolio to meet the goals of the prospectus.

Investing in a mutual fund means you become a shareholder in the fund and your money is subject to the wins and losses of the portfolio.

Exchange-traded funds (ETFs)

An ETF can be bought or sold on the market, hence the name “exchange-traded.” The most recognizable example of an ETF is the Standard & Poor’s 500 (S&P 500), which tracks that particular index. These indices can be designed to focus on a single commodity or diversify over stocks, bonds, and other mixtures of investment types. Since ETFs are traded on the market, their values fluctuate throughout the day, while a mutual fund is priced once per day after the market closes.

Both mutual funds and ETFs can have risk profiles from conservative to aggressive, with lots of variations in between. That brings a different set of considerations when deciding how to invest your 401(k).

Other considerations for how to invest your 401(k)

Risk tolerance

On September 6, 2008, financial markets were down nearly 20% from their peaks in the previous year. Economic chaos ensued, with people losing homes, jobs, and the savings they had built in their 401(k) and other retirement investments.

With the confusion and unprecedented financial upheaval happening on the world stage at that time, it’s understandable why many would panic and sell everything they had. However, if people had held on to their savings and ridden out the cycle, they would likely be up hand over fist in their investment accounts today. Instead, far too many people panicked and lost everything.

This is where risk tolerance comes in when determining how to invest your 401(k). It’s important to know that the market goes in cycles, and while it’s close to impossible to time the market, you can certainly count on there being ups and downs throughout your career.

As with so many things in life, the axiom “know thyself” comes into play. If you’re risk-averse, own it. If you’re a maverick ready to sail the choppy seas of the next market upset, own it.

You’ll go through ups and downs. But as Tony Robbins says in his book “Money: Master The Game,” the biggest risk is sitting on the sidelines and not getting into the market at all.

Age: just a number or determining variable for investing decisions?

Yes, age is a state of mind, and yes, all the serums you’re slathering on your face and neck will keep you looking 23 until the end of time. However, when looking at your retirement strategy, vanity needs to step aside for just a moment so age can play its role as a practical determining factor in how to invest your 401(k).

The general rules of age and how to invest your 401(k) are as follows:

  • If you’re younger and just starting, you can afford to invest in riskier funds.
  • As you grow older, allocate funds from riskier stocks to “safe havens.” Safe havens are investments that will remain stable or even grow during times of market volatility.
  • The exact numbers have changed over the years, but the formula for what percentage of your savings should be invested in stocks is 110 minus your age.

Conservative fund investing for risk-averse investors

Not into your finances taking a metaphorical roller-coaster ride every day in your investing app? High-quality bonds are the way to go if you’d like to avoid risk as much as possible (remember: no investment is completely risk-free).

Maverick money management for aggressive investors

You’re in the amusement park, knowing how to invest your 401(k), and you’re ready to go on all the rides, no matter the ups, downs, and twisty turns. For you, it’s prudent to be aware that what looks like the next Tesla could actually be the next Pinto, but if you have high-risk tolerance, build your portfolio in funds that are trying their best to find the next big thing.

Goldilocks investing for something that’s not too crazy, not too boring, but just right

There’s nothing wrong with saying “yes … AND” by creating a portfolio of the old slow-and-steady bonds AND the more volatile equities when deciding how to invest your 401(k). This can be an ideal strategy for people just starting their investment journey since they can learn more about the different investments while getting a deeper understanding of which strategy is the best for them.

Decide how much to withhold from your paycheck

As with most investing strategies, it all starts with a decision to even get in the game. You may be looking at your current bills and paycheck, thinking there’s no way you could afford to stash any extra money away.

And, as with most investing strategies, it’s incumbent on the investor to look at long-term gains while possibly taking a short-term hit to current lifestyle choices. In the classic book “The Millionaire Real Estate Investor,” Gary Keller invites the reader to take a breath every time they’re about to pull out a credit or debit card and say to themselves: “I am an investor.” 

This mantra will shift your mindset faster than a Kanye rebound relationship as you start to focus on the bigger picture.

Once you shift your mindset, decide how much you’ll commit to putting aside from your paycheck. Even if you’re starting with a small percentage, remember that compound interest is your friend, and over time, you’ll fully know the thinking behind “every bit counts.”

Okay, but really, how much? 

If you want to get real, all you have to do is calculate how much you’ll need for retirement. When you consider life expectancy increases and the historical rate of inflation, it’s clear to see there’s no time like the present to start saving once you’ve learned how to invest your 401(k).

General conservative estimates are a 5-6% return on your 401(k), and you’ll want to plan on being able to replace at least 80% of your income after retirement.

And now for the fun part

You’ve set up your account, and you’re depositing money. You’re finding that the pinch on your pennies actually isn’t that bad and that Gary Keller mantra of “I am an investor” is kind of powerful when you’re pulling out your wallet for that pair of high-end jeans you just know will make you (and your bum) the star of casual Friday.

Instead, you become more preoccupied with studying and monitoring the numbers in your 401(k). This is where the fun starts and the journey to knowing thyself even more begins. You’ll get a real-time understanding of what markets are doing and how they affect your financial future. Remember to keep the long-term picture in mind, as saving and investing are not for those who can’t live without instant gratification.

As Warren Buffet, possibly the world’s most famous investor, says: “The stock market is a device for transferring money from the impatient to the patient.”

Final thoughts

Knowing how to invest your 401(k) might not be the coolest way of securing your future. But it’s certainly a tool with quietly dignified appeal for anyone willing to see the value in a slow and steady long-term courtship with a portion of their salary. Remember to keep your eye on the prize: a secure and joy-filled retirement while having the resources to stay forever young.

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