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401k Asset Allocation: Two Methods for Headache-Free Diversification

Is your 401k asset allocation set correctly? Failing to check could cost you $10,000 or more! Here are two easy methods for ensuring proper allocation.

Failing to diversify the investments in your 401k is a top mistake investors make.

Want to do one thing to ensure the money you’re saving today in your 401k or IRA will be around tomorrow?


Too many Americans have watched their retirement dreams disappear because they invested solely in the company stock of their employer.

It’s never a good idea to put all your eggs in one basket. No matter how big, stable, or fast-growing a company you work for, it can fail. And if it does, not only will you be out of a job, but that company stock (and your 401k) will be worthless.

So if you don’t read any further and your 401k provides the option to invest in your employer’s stock, make sure that’s not the only investment you hold. Can you buy some? Sure! And if you can buy shares at a discount, all the better. Just make sure it doesn’t represent more than 10 percent of your total investment holdings.

Today’s post is a lesson in 401k asset allocation (or, simply put: diversification). We’ll move from simple to slightly more advanced.

The Easy Way To Diversify

If you want nothing to do with managing your investments, no problem: Choose a target-date mutual fund.

Most 401ks are beginning to offer these from a variety of companies. You simply figure out the date you will begin to withdraw money (for example, if you’re 25 in 2012 and want to retire when you’re 65—in 2052—you would choose a 2050 target-date fund).

The upside to these funds is that they continually rebalance as you get older. They start out aggressive (and more risky) and become less risky with time.

The downside to these funds is some have higher-than-average expense ratios and, obviously, they take control away from the investor.

Full Control Diversification

If you want more control over your asset allocation or your 401k does not offer target-date funds, choose:

  • One stock mutual fund
  • One bond mutual fund


  • One domestic stock mutual fund
  • One international stock mutual fund
  • One bond mutual fund

Mike Piper provides good examples of simple portfolios that use low-cost Vanguard index funds. (This, by the way, is how I’ve invested most of my own retirement funds—in just four Vanguard index funds.)

So how do you choose the right allocation? As you can see, the guidelines recommend buying more bonds and fewer stocks as you get older. This is because bonds are less volatile and less likely to lose large amounts of money in a year or two. They’re also less likely to deliver huge returns.

The old rule was to subtract your age from 100 to get the target allocation of stocks. So if you’re 25, 100-25 is 75 and you would have 75% stocks in your portfolio. As we’re living longer, however, we need to earn bigger returns to make our money last in a longer retirement, so that rule could be subtract your age from 110 or even 120.

Here are very rough guidelines for 401k asset allocation:

Decade Domestic Stocks Foreign Stocks Bonds
20s 60% 40% 0%
30s 60% 30% 10%
40s 55% 25% 20%
50s 50% 10% 40%
60s 35% 5% 60%
70s 30% 0% 70%

An Example Retirement Portfolio for a Young Investor

Example of a Portfolio Allocation

Your 401k Asset Allocation

How you allocate your 401k should depend on your age, but also your tolerance for risk. If a big stock market crash like we had in 2008 were to wipe out a third or your portfolio’s value, would you?

  • A: Sell your stocks as fast as you could.
  • B: Do nothing.
  • C: Buy more stocks at a discount.

If you answered A, you should probably stick with a conservative portfolio of more bonds and fewer foreign stocks.

If you answered B, the above guidelines are good for you.

If you answered C, you may want a more aggressive approach and hold even more stocks even as you age.

As an example, right now, my allocation is 80% stocks, 12% bonds, and 8% alternatives (some real estate through a real estate index ETF). I’m staying a little bit on the aggressive side because:

  • I don’t have a ton of money invested yet.
  • I’m optimistic about economic growth over my lifetime.
  • I still have got a long way before I retire.

Adding Alternatives

Not all 401k plans will have alternative investment options. These include ETFs or mutual funds that invest in things like:

  • Real estate
  • Commodities like Gold or Silver
  • Debt obligations

For the average investor, I think alternatives should make up less than 10% or your portfolio. I like alternatives because they provide further diversification, and some can serve as a hedge. For example, the price of gold and silver typically moves opposite the stock market. So owning some ETFs that invest in metals can mitigate losses when the markets have a bad year.

Beyond Your 401k

Although 401ks are great, you will hopefully have other investment accounts, too (like a Roth IRA). So the diversity of investments within your 401k is only part of the picture.

Ah, this sounds like it’s going to get complicated! Deep breath.

The easiest way to ensure you’re allocating your assets correctly s to diversify within each account. Remember I’ve said before that a 401k or IRA is like an empty bucket into which you place eggs (your investments). So if you have three buckets—a 401k, a Roth IRA, and a taxable investment account, you can place different eggs in each.

You might have 80% stocks and 20% bonds in your 401k, the same ratio in your Roth IRA, and 50% bonds and 50% stocks in your taxable account (a more conservative allocation because you may use the money much sooner than retirement).

The more sophisticated way to accomplish this is to look at your entire retirement portfolio at once. For example, if your 401k is entirely invested in stocks and is worth $80,000 and you have $20k in a Roth IRA, you could put that money in bonds to achieve an 80/20 stock bond allocation. Some brokers have tools that allow you to look at the compensation of your entire portfolio whether or not the assets are with that company.

Programs like Personal Capital can help you view your asset allocation across accounts in one place.

Emerging tools like Personal Capital (shown above) make this easier by aggregating your investments and giving you an x-ray of your portfolio’s contents by asset class, sector, and more. Above, a screenshot of Personal Capital’s investment screen shows the asset allocation of all your investment accounts in one place.

What’s Most Important

This post scratches the surface of asset allocation, but what 99% of investors need to remember is that diversification is good. Diversification protects you. So owning a mutual fund that holds 25 different stocks is good. Owning three mutual funds that hold 100 different stocks and bonds is better. And, some argue: owning three index funds that track thousands of stocks and bonds is better yet.

To be simpler still, just remember these three secrets to successful 401k investing:

What about you? How is your 401k diversified?

Need 1-on-1 advice? Learn how to find pre-screened financial advisor in your area here.

Published or updated on December 16, 2013

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About David Weliver

David Weliver is the founding editor of Money Under 30. He's a cited authority on personal finance and the unique money issues we face during our first two decades as adults. He lives in Maine with his wife and two children.


We invite readers to respond with questions or comments. Comments may be held for moderation and will be published according to our comment policy. Comments are the opinions of their authors; they do not represent the views or opinions of Money Under 30.

  1. Excellent piece of information all about diversification. The way implementation is shown is outstanding. Every should think for it if he want to stand strong for long term. By the way I am totally newbie in this field but your articles make me thinks to jump in deep down. thanks to share it over here.

  2. Tyler says:

    Just a quick note. If you have $80,000 in stocks in your 401k and $20,000 in bonds in your Roth IRA, I don’t think that it is really accurate to say that your asset allocation is 80/20. You are really closer to 75/25 once you factor in taxes. (The 401k withdrawals will be taxed, the Roth IRA will not)

    Your point is still valid, I just think that it is important to always keep tax diversification in mind, as well as asset diversification.

    That being said, great article.

  3. Drew says:

    I am really heavy on stocks, 90% in diversified individual stocks and 10% in a target date fund. Being an investment nerd, I like doing the research and watching my investments daily.

    I am really heavy on stocks because I have a conservatively invested pension with my company that will make up 4-5 million of my retirement if I take the lump sum option. So when looking at my total picture, I really am only 40% stock.

  4. Our investment portfolio has 3 main categories:

    1) Real Estate
    2) SEP IRA & IRA (self employed)
    3) Cash

    I am, like Adam Porter, debt free! We just paid off our mortgage + own an investment property that is also paid off is rented out. Therefore, real estate portion of the portfolio is currently heavy but it was a conscious decision; we just wanted to be debt free.

    SEP IRA & IRA portfolio has 3 mutual funds; growth, income & developing nations

    Cash is the least now since we just paid off the house.

    My ideal portfolio percentages would be 20-40% real estate, %50-70 stocks, %30-20 cash + bonds. I like being conservative.

  5. Adam Porter says:

    I’m finally 100% debt free (at 32, to boot)!

    While I kept my company’s 401(k) contributions going, unfortunately I neglected my Roth IRA. However, this article was unbelievably timely, for me. Thank you, David.

    I’m analyzing both the 401(k) and Roth IRA and seeing a LOT of changes that need made. Time to stockpile and invest some cash!

  6. Jon says:

    Great article, and something that people really need to consider a lot more than they do. For me, I take the easy way out with my Roth IRA – a target fund that automatically diversifies for me. For my 401K (which doesn’t have that option), I try to get a good mix of stocks (and in there a mix of large, mid, small, foreign) and bonds. I really like the target funds…

  7. I think many young investors feel overwhelmed at the possibility of investing, so this lesson of diversification can take away the huge risk that they associate with it (usually because they choosing only a few stocks and hope to see big increases).

    I appreciate your recommending choosing a mutual fund with a much greater number of stocks so that people in their twenties can focus on the pressing financial issues of budgeting and debt that affect them on a monthly basis.

  8. Kathryn C says:

    Great article.
    My 401k is so not diversified.

    I have about 60% in stocks, 20% in HY Bond fund, and 20% in ST treasury fund. I’m going to sell out of the ST treasury fund asap.

    Just thinking where I want to put that last 20%. Will probably do some sort of commodity fund. I’m very aggressive in my 401k and not as aggressive with my money outside my 401k.

  9. Mike says:

    I have a Thrift Savings Plan from the federal government that is allocated using the 120 minus my age rule. 120-28 = 92% in stocks. 47% in the S&P500 (C fund), 30% in the small cap (S fund), 15% international stocks (I Fund), 3% in bonds (F Fund), and 5% in government securities (G Fund), which is equivalent to cash.

    Each year I age, I am putting 1% more in the F fund and removing from the C Fund for now. Eventually I will begin lowering the S and I funds, as I approach retirement in 2041, when I plan to have about 40-50% in stocks, and the rest distributed in the G and F fund.

    Roth IRA: VFIFX Vanguard target retirement 2050, invested directly with Vanguard. No middle-men with their hands in my retirement stash.
    Other: High yield savings for my upcoming house purchase in October 2012. The leftover is going to be cash reserves, and hopefully a taxable stock/index mutual fund account beginning in 2013.

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