Where to stash your 401(k) cash

Saving as much as possible is the first and most important step. Now, for where to put the money...

By Walter Updegrave, Money Magazine senior editor

NEW YORK (Money) -- Question: I contribute 5% of my salary to my 401(k), which my employer matches, bringing the total contribution to 10%. My problem is that I don't know which mutual funds I should be investing in. Can you help? - Antonio Lara, Oklahoma City, Oklahoma

Answer: Before I answer your question, let me say that I think you're doing the right thing by contributing to your 401(k) even though you don't really understand the investment options. Stymied by the investment options, many people just "postpone" the decision to contribute for weeks, months, years...and before you know it, retirement is looming and they've got zip tucked away for retirement.

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At least you've gotten into the game, which makes the worst-case scenario that your contributions might earn a lousy return. But at least you're building a nest egg. And there's always the chance that someone who contributes to a 401(k) even though he or she isn't sure how to invest the money will eventually begin to think (as you apparently are), "Hey, now that I've got this money in my account, why not take the next step and try to do a better job of putting my contributions to work?"

So let's get to that next step, which is putting together a coherent investing strategy for your money.

People in your situation typically have three options: build a portfolio of mutual funds on their own; build a portfolio of funds with help from an investment pro; invest in a fund that gives you a ready-made investment strategy.

I'll explain each of the options so you can judge for yourself which is most likely to work best for you.

Build a portfolio on your own

Going this route requires that you know a bit about investing. In particular, feel comfortable about building a portfolio of stock and bond funds of various styles that complement each other and in proportions that make sense for you given your age and stomach for risk.

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If you're young, for example, you might put 80 percent of your money in stock funds that represent a mix of large and small stocks as well as growth and value issues, and the remaining 20 percent in diversified bond funds.

You don't have to get fancy. Indeed, you could pull this off with just two funds - a broadly diversified stock index fund and a bond index fund that tracks the overall bond market.

You don't have to be an expert to do this, but you should understand basic investing principles, which you can easily pick up on your own by reading our Money 101 lessons. To get the mix right, use the Asset Allocator.

But if you're not totally comfortable, you're probably better off moving to one of the options below.

Invest in a fund with a pre-set strategy

Most 401(k)s these days have funds available that are a fund and an investment strategy rolled into one. One example is an asset allocation fund, which automatically divvies up your money among a broad range of stocks and bonds.

Typically, asset allocation funds come in several flavors: growth or aggressive growth, which typically tilt their mix toward stocks; moderate growth, which also focuses on stocks, but less so; and conservative, which tends to rely more on bonds than stocks.

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The mix of stocks and bonds in an asset allocation fund tends to be relatively stable, fluctuating only within certain pre-set limits. So by choosing one of these funds, you're assured that you'll get a diversified portfolio and that your mix of stocks and bonds will stay within a given range.

But there's another type of fund within this "fund that doubles as an investment strategy" category that I think is an even better choice for most people - a target retirement fund.

With this type of fund, you choose a fund with a date that roughly corresponds to the year you plan to retire - 2020, 2030, 2040, whatever - and you get a fund that has a diversified mix of stocks and bonds appropriate for someone your age.

Unlike an asset allocation fund, however, the mix in a target-fund gradually shifts more toward bonds as you age. The idea is that it becomes more conservative as you near and enter retirement and want more stability and less growth in your investment portfolio.

Because these funds require so little effort and deliver what amounts to a coherent investment strategy that can carry you to and through retirement, they've become an increasingly popular choice among 401(k) investors, especially for people who aren't into choosing and tracking investments. See more on how asset allocation funds work.

Get help from an investment pro

If you really feel uncomfortable about investing on your own or you just want some guidance initially, there are several possible ways to go.

Many 401(k)s now offer an advice component of some sort. The options could range from the opportunity to consult with a financial planner or other adviser to choose funds to a system where an investment adviser actually creates a portfolio for you and monitors it on an ongoing basis.

Other plans may offer guidance through an online service, such as Financial Engines, Guided Choice or Advice by Ibbotson, that can help you set a saving and investing strategy to achieve a comfortable retirement and, if you wish, manage your 401(k) investments.

If this route appeals to you, check with your plan to see if it makes such advice options available. While you're at it, be sure to get details on how much, if anything, you must pay for this advice. If your plan doesn't offer this sort of guidance, you can always hire an adviser for help (for more on how to do that, click here or sign up for a service like Financial Engines on your own.

One final thought. If none of these options seems like the obvious choice for you, why not move your money into a target fund, assuming one is available, and then look into the alternatives further. You can always make a switch later on within your 401(k) without concern for tax consequences. And you'll know that your money is diversified and you're following a coherent investment strategy while you're mulling things over.


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