Within an employer-sponsored plan like a 401(k), there are lots of possible investment options. Of those options, mutual funds are among the most common investments.
The financial industry breaks mutual funds into large categories – called asset classes.
Some of the most common asset classes are explained in the graph below. Asset allocation refers to the way an individual investor divides money between these asset classes – and between other non-mutual fund investment options if applicable.
The most conservative investments have historically been insured or guaranteed by the United States government. An example is a Treasury bill or bond. Traditionally, small/mid-company funds and international funds are more aggressive and volatile. The chart below briefly describes and ranks the level of risk and volatility of several of the most commonly available assets classes in employer-sponsored retirement plans.
To understand the real-world application of these concepts, look at the charts below:
Investor A will not retire or need account access for more than 10 years. This investor is comfortable investing for the duration of a career and is willing to endure short-term market volatility in exchange for the possibility of higher long-term returns. Because of the investor’s time horizon and willingness to tolerate risks, Investor A is invested in a more aggressive allocation.
Please note: This allocation does not represent a recommendation of advice by Smart401k, is not tailored to your specific situation and may not be proper for your situation.
Investor B has fewer than 10 years until it will be necessary to take distributions from this account. The investor has been an active investor for an entire career and is most comfortable with a more stable account. Investor B is unwilling to endure short-term market volatility in exchange for the possibility of higher long-term returns. Because of the investor’s time horizon and unwillingness to tolerate risks, Investor B is invested in a more conservative allocation.
Please note: These allocations do not represent a recommendation of advice by Smart401k, is not tailored to your specific situation and may not be proper for your situation.