Most people understand the importance of investing in their 401k, but I’d venture to say that many do not understand how to properly update the investments inside of their 401k. In fact, it can be very confusing (and frustrating) since there are actually three places that you need to make updates, not just one! And if not handled properly, you could end up having to work longer because your investments didn’t grow as expected.
Let’s assume for a moment that for whatever reason, you don’t like the current investment mix (i.e. allocation) of your 401k.
Perhaps you’ve listened to my advice in the past and you feel like you have too much exposure to large cap growth stocks (i.e. tech stocks) in your 401k. Or, maybe you’ve been far too conservative or aggressive and it’s time for a change. Or, you decide to target investment that have higher expected returns.
Whatever the case, you decide it’s time for a change.
STEP 1: UPDATE CURRENT INVESTMENT MIX
Typically people will update their current 401k investment mix to incorporate their new investments or strategy. However, you shouldn’t stop there. There are two more places you’ll need to make changes.
STEP 2: UPDATE FUTURE CONTRIBUTIONS
Even though you changed how your current investment mix is invested, you’ll also need to update how your contributions are invested. If you don’t update this, then your contributions will be invested according to your old strategy and you will likely have investments in your 401k that you don’t want.
STEP 3: CREATE A REBALANCING SCHEDULE
To top it off, you need set up a schedule to rebalance your investments. Over time, your investments will go up and down at different paces. This will result in you having too much or too little exposure compared to the investment mix outlined in Step 1 above.
To remedy this, you’ll need to rebalance back to the intended target (Step 1) every so often. Most people choose quarterly or annually. It doesn’t really matter which one you choose, but what does matter is that you do it!
Some 401k plans do a much better job than others at making updating your 401k investments easy. But for the most part, I’ve seen this be a source of confusion and frustration for many people.
So, the next time that you need to update your 401k investments be sure to update your current investment mix, update your future contributions, and set up a schedule to rebalance periodically to your new strategy / investment mix.
Did you know there were three places to make changes to your 401k investments? I’m curious to know. Please share in the comment section below.
Brad E.S. Tinnon
CERTIFIED FINANCIAL PLANNER™