Aggressive? Conservative? How to Choose the Right 401(k) Mix
By Allison Kade
You might’ve heard that the first step toward saving for retirement is simply diving in. That’s true, but what about step two? If you’ve signed up for a 401(k), you’ve probably seen a bunch of options right off the bat. Namely, most provide the ability to choose based on your risk appetite, whether you want to invest in an “aggressive” or a “conservative” portfolio, or something in between.
The wrong decision can have ramifications that could even determine whether you can afford to retire or not.
First, let’s talk about what risk really is, and how that relates to you.
The Real Meaning of Risk
Sure, maybe you’re down to go skydiving or bungee jumping, but that doesn’t tell us enough about how risky you are willing to be with your money. Typically, when we talk about higher risk or aggressive portfolios, we’re referring to those that invest in a lot of stocks. Since stocks are shares of a given company, you could make a lot of money if you invest in a winner, but you could lose money if that company goes bust.
A more conservative or lower-risk portfolio is one with a higher mix of bonds. Although no investment is a sure thing and it’s always possible to lose money, bonds are generally seen as safer investments. Instead of buying a piece of a company as you would with a stock, buying a bond means lending money with a promise of getting it paid back with interest. The risk comes in if that company goes bankrupt and can’t pay you back, but if it’s a high-quality company, the risk of that happening is considered very low.
In exchange for this promise of return, however, the money-making potential is generally lower. The safer you get, the lower the return you can expect. A particularly safe option is to invest in U.S. government debt, because you can expect not to lose money unless the U.S. government defaults (and then there might be bigger issues to contend with!).
When it comes to choosing a prefabricated risk profile for your 401(k), you don’t have to worry about choosing specific stocks or bonds. You only need to understand what risk means in this context, and where you fit in.
How Much Risk Can You Handle?
Generally speaking, the longer you have till you need your money back, the more risk you can – and should – take on. If you are 25 and investing for retirement, you have over 40 years for your money to grow; if you sock it away in low-return, safe investments, it might not grow sufficiently to truly allow you to retire comfortably. On the flip side, if you’re 50 and put your money in high-risk investments, you could lose your best shot at retirement the next time the market tanks, because you won’t have the time to recoup your losses.
As a rule of thumb, the younger you are, the more aggressive you should be. The closer you are to retirement, the more conservative the option you should choose. To narrow down the right strategy for your situation, take the Wells Fargo risk tolerance quiz and consider choosing the option offered by your 401(k) that most closely matches your results and your comfort level.
And most of all, remember that to get to step two, you need to take care of step one: Don’t let yourself get overwhelmed by all the options, because it really is most important simply to get started!