By: Jeff Headrick, Financial Planner
Your 401k may run more smoothly with efficient asset allocation. And the closer you are to retirement, the more this may matter.
If you are nearing retirement you know more than most people how much balance life requires. Every year I realize that with just my personal to do list, I can easily be overwhelmed. Every week I try to do the following in order to live my version of a balanced life:
- Spend time with God 2. Love on my family 3. Work out 4. Eat right 5. Work hard 6. Get quality rest 7. Study finance 8. Stay productive around the house 9. Inspire others 10. Save for retirement 11. Manage personal finances well 12. Maintain a positive attitude 13. Maintain a heart of thankfulness 14. Be open to helping others
I could go on, but you get the point. Many of us have goals to achieve, and standards to maintain, but without a balanced approach to life it can all turn to mayhem in an instant.
It’s similar with your 401K.
As in life, balance is usually a pretty good thing. And like I mentioned before, the closer you are to the withdrawal phase of your life savings, the more this efficient asset allocation thing makes sense.
What is Asset Allocation?
So, what is asset allocation? We know that we need to diversify. We’ve all heard the old adage, “don’t put all your eggs in one basket.”
And asset allocation, is simply moving forward with that theory. The goal is to take our assets and allocate them to different places. The goal in life and in investing, at least in part, is to spread stuff (time, resources, money) around.
Keeping It Simple
This post is not for academics. I’m not here to argue current correlations and standard deviations of a plethora of asset classes. This article is for everyday folks who simply need a better understanding of the efficacy of asset allocation.
We know from history that at times certain types of bonds can go up in value when certain types of stocks go down. It certainly doesn’t happen like this all the time, but to maintain a balanced and efficient approach to 401K allocations, one might consider placing as much thought into their bonds as they do into their stocks.
Below is a graph that shows the behavior of intermediate-term government bonds from 1968 until about 2002. I like this graph even though it only includes one type of bond (intermediate-term government bond) to the U.S. Stock Market. My rationale being that most 401K plans that I’ve seen in my experience as a financial planner, do offer intermediate-term government bonds of some kind for you to choose from in your 401K, if you so desire.
Source: Alliance Bernstein/ The Power of Low-Correlation Investing U.S. Stocks are represented by the S&P 500 index. Bonds are represented by 5-year U.S. Treasury securities. Graph by Inspire Financial Planning.
I like this graph because it gives us a very simple perspective as to how bonds can perform during market gyrations. At first glance this graph would look a little misleading, because of the consistency of positive bond performance during times when the average retirement savings account was getting clobbered, in some instances to the tune of -30% to -40%. Again, the closer you are to retirement the more pain you may feel during such a timeframe.
If you are in your 20s or 30s reading this, you can just lick your chops. Because you know that behind every cloud is a silver lining. If you are young and have time on your side, you can simply double down and invest more money during these stock market “clearance sales”.
Arguments Against Bond (Fixed-Income) Investing
Not all would agree with me that bonds are quite this important. There is a lot of research that shows stock and bond behavior are more evenly correlated than in the past. And I don’t deny that research. However, I saw firsthand how some of these bond (fixed-income) positions can behave during the Financial Crisis of 2008. And while 2008 seems like a long time ago, it’s still the most recent experience we have with a blood in the streets type of market.
Some Positive Results in 2008
I wish I had a dollar for every time I heard that there was nowhere to run in 2008. With investing, as in life, a lot of times it boils down to what you read, and the order that you read it. Apparently, I was reading the right diversification books from authors like Richard Ferri, and William Bernstein back in 2006 and 2007. Either way, most of my clients at that time had at least a portion of their portfolio head into positive territory in 2008.
The cool thing is, the more conservative they had been prior to the crisis, the better their performance over the short term.
Look at the graph below. Notice that there was some bond (fixed-income) asset classes that went south with the market (U.S. High Yield), but there were a few that went into positive territory (U.S. Government Long, U.S. Government Short, U.S. Government Medium. And while you may not have all of the options below available in your 401K, you may have some of them.
Source: Alphastar Capital Management Periodic Table of Investments. Graph by Inspire Financial Planning.
Think Before You Act
Incidentally the goal of all these positive thoughts on bond investing is not to get you to act. I felt inspired to write about the efficacy of asset allocation in your 401K to get you to think.
Read, research, think, seek expert advice, and then, maybe, act. Catch my drift? A wise man seeks counsel. I recently wrote an article for beginners who have never worked hand-in-hand with a professional financial planner or financial advisor. Maybe this could be useful in seeking out a professional opinion before you go to work reallocating your 401K.
The Perfect World
In a perfect world I would live a completely balanced life, both personally and professionally. In a perfect world, all of my client’s assets would be perfectly allocated and balanced as well.
But we do not live in a perfect world. We live in a world that requires study. Prayer. Thought. And counsel from others. But fortunately for all of us who are blessed enough to be literate, there is a massive amount of information out there available to us. Information that if applied, can truly make a difference in our lives. How cool is that?
Good luck with your life pursuits to include a healthy and balanced 401K. Let us know if we can help.
About the Author
Jeff Headrick is a independent financial planner with Inspire Financial Planning. When Jeff was still in his teens his father died unexpectedly. While his father was a hard worker and a good provider, he did not have the best financial plan in place when he died. This personal experience, coupled with being inspired by Sir John Templeton, Warren Buffett, Dave Ramsey, and the laws of compound interest, prompted Jeff to enter the financial services industry in 1999. He has been helping people with their financial planning ever since.
Jeff lives in Wilmington, NC with his wife and two children. He spends most of his spare time just across the Intracoastal Waterway in Wrightsville Beach, enjoying the beauty of the NC Coast.
Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance. The information presented does not constitute financial, legal or tax advice and should be used for informational purposes only. Since individual circumstances vary, you should consult your legal, tax, or financial advisors for specific information.
Investing involves risk including the potential loss of principal. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Diversification does not guarantee profit nor is it guaranteed to protect assets. International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. Opinions expressed are subject to change without notice and are not intended as investment advice or to predict future performance. Past performance does not guarantee future results. You cannot invest directly in an index. Consult your financial professional before making any investment decision.