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Get Your Financial Ship Back on Course

The 3 step process to make sure your 401(k) portfolio and investments are working for you.

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If you’re among the millions of Americans who lost their breath and possibly some money going through the roller coaster ride of 2020 with your investments, just know you weren’t alone. But let’s make this year different. I expect that there will be more ups and downs and volatility this year. Instead of you going through the ups and downs emotionally or standing frozen in fear, it’s time to yourself back in control.

Let’s right your financial ship

It’s time to get the ship of your financial future back on course and put you back at the helm as captain in 2021. One of the best ways to do that is to have the right plan, with the right vehicle, with the right routines. For many that vehicle is a 401(k) plan or an Individual Retirement Account (IRA). My preference is the 401(k) because it allows you to contribute as much as $19,500 ($26,000 if you’re age 50 or over) whereas the IRA only allows you to contribute $6,000 ($7,000 if you’re age 50 or over). Also, with the 401(k) often your employer matches a percentage of what you put in which is effectively free money.

My suggestion is to get your contributions up to 15%-20% of your income over time. I know this sounds like a lot but to get you to true financial independence as you get older, the earlier you get your future funded the easier it is on you because time will do the heavy lifting for you.

For example, just $200 per month invested at 8% over 30 years will grow to over $300,000. Think about that, you invest a total of $72,000 ($200 x 12 months x 30 years) and get back over $300,000. And that doesn’t even consider any matching your contributions your employer makes. Let’s take it one step further. Assume you went closer to the maximum and contributed $1,500 per month. This would end up at over $2,200,000. Time and consistency is your friend when preparing for financial independence.

But what if you already have a 401(k)? What should you do regularly? Well here’s the thing, your retirement and financial future aren’t a “set it and forget it” type of situation. In fact, I tell people that if you forget about your money and wealth in time it will forget about you!

Investments in your 401(k) will grow at different rates and can cause your portfolio to fall out of balance with your goals or the level of risk you want to accept. You may even find that some investments that made sense in the past do not any longer. So there are three things you should do each year. This is what I call the rebalancing and reallocation process.

Evaluate — Evaluate first what your needs will be in retirement. You want to have a definitive goal to move towards so you can manage to a target. Second, evaluate what is your current 401(k) balance. This allows you to what you have, how much it’s grown, and what you still need to get to your target. The last thing to evaluate (if you aren’t at the maximum already) is how you can increase your contributions this year so you can accelerate your path to financial independence.

Assess — Investing doesn’t come without risks and how much risk you’re willing to accept depends on your current stage of life, how much you have saved already, and your circumstances (i.e. children, grandchildren, medical needs, etc.). This is why financial planners typically have their clients complete a risk tolerance assessment. You can also find these assessments online. They will help figure out the best type of portfolio for your situation.

For instance, a 30-year-old might take a more aggressive portfolio position of 70% in stock funds and 30% in bond funds whereas a 60-year-old would be much more conservative at something like 40% stock funds and 60% bond funds.

So in this step, you simply compare the risk tolerance assessment results with your current investments to determine if you are overinvested or underinvested in certain asset classes. This is a way to manage how much risk you are taking on in your 401(k). With this information, you can now move to the last step.

Rebalance — Over time the portfolio may move away from your desired target percentage allocations. For instance, those that stayed in the stock market in 2020 found that the percentage of money invested in stock funds was much higher than their target. This difference was caused by the growth of the stock fund investments in their portfolio. Looking again at the example above, say at the end of the year the 30-year-old’s 401(k) was at 80% stock funds and 20% bond funds compared to their target of 70% stocks and 30% bonds. This means it is time to rebalance and reallocate.

There are two possible ways to rebalance to get back to your target portfolio allocations. The first would be to sell some of your stock funds and buy bond funds. Often you sell the funds that had the highest growth so you can lock in your gains.

The second way to rebalance would be to simply direct any new contributions (in the current year) to the bond funds until you get back to your target allocation percentages.

Target Retirement Funds — If this is too much you could have your 401(k) invest in what’s called “Target Retirement Funds. These are funds that are built for a specific retirement date range. The fund itself rebalances based on a target date of retirement. The closer that date is, the more conservative its portfolio becomes. If it gets out of balance the fund itself will rebalance based on its objective and target date. The funds tend to have the retirement year in the name (i.e. Vanguard Target Retirement 2030 Fund (VTHRX) is for those planning to retire between 2026 and 2030).

There are some things to be aware of with these funds though. They typically have higher expense ratios which cut into your returns. The funds may be either too conservative or too aggressive based on your needs and desires. The fund isn’t built around your specific circumstances rather a broad base of assumptions.

I hope you found this helpful as you set yourself up for success going forward. The bottom line is for you to realize that you ARE in control and to never relegate that control to someone or something else. Keep rocking and making a difference.

This article is for informational and educational purposes only. It should not be considered financial or legal advice. Not all information may be accurate or applicable to you or your specific circumstances. Always consult your own financial professional before making any major financial decisions.

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