First job? Start your first 401(k)

Confused about how to invest your 401(k)? These guidelines should help you get started.

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By Walter Updegrave, Money Magazine senior editor

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Walter Updegrave is a senior editor with Money Magazine and is the author of "How to Retire Rich in a Totally Changed World: Why You're Not in Kansas Anymore" (Three Rivers Press 2005)

NEW YORK (Money) -- Question: I just started my first job and have to decide how to allocate my contributions to my 401(k) plan. Since I'm only 23, I think I can assume more risk than older workers, but I'd like to know what allocation you would recommend. --Bob Dixon, North Andover, Mass.

Answer: You're right that a young person like you who has a good 40 or more years before retirement can typically afford to take on more investing risk than people who are much farther along in their careers.

That means you should likely be investing a hefty portion of your 401(k) money in stocks. Although there are no guarantees, history shows that over very long periods stocks usually generate loftier gains than more stable investments like bonds or cash equivalents such as short-term CDs and money-market funds. And those higher returns translate into a larger nest egg later in your career.

Granted, the more of your 401(k) contributions you funnel into equities, the more vulnerable you are to serious shocks like the 57% drop in stock prices from the market's high in late 2007 to its low point last March. But that shouldn't be an overriding concern for someone just starting out, as you'll have decades to recoup any losses.

Besides, you've got to remember that with a 401(k) you're continuously investing small amounts of money over time. And as the financial markets go up and down, you'll earn higher returns on some contributions and lower returns on others. What's important is that you end up with enough dough in your account as you approach the end of your career that you'll be able to enjoy a secure retirement.

So how, specifically, should you allocate your 401(k) assets?

Assess your risk tolerance

You can certainly quibble about the precise percentages, but I'd say that someone your age should generally be investing about 90% of his 401(k) in a broadly diversified group of stocks and the remaining 10% in bonds.

I say "generally" because there are always reasons any individual might want to fine-tune that allocation to his or her particular circumstances. If, for example, you get so upset when the markets head south that you might be tempted to flee stocks, then you might want to dial back your stock percentage a bit, say to 80% or 75%. I'd be wary of going much below that, however, as you may be unnecessarily stunting the future growth of your nest egg.

Conversely, if you're willing to go with a bumpier ride for the possibility of higher returns, you could up the percent you devote to stocks. But, again, I don't think you want to go too far. I suppose one could argue that at your tender age you can afford to go 100% in stocks, but I feel it's always good to hedge your bets even if only a bit.

Tune out the talking heads

Speaking of diversification, it seems everywhere I turn these days some pundit or another is talking about how all the rules of diversification have changed and that divvying up your portfolio between stocks and bonds is no longer enough. Now, these savants say, you need to venture into "alternative" assets, which could mean anything from hedge funds to commodities to real estate to god knows what else.

I'm not against spreading one's money around. In fact, I think the stock portion of your portfolio should include the full spectrum of equities -- i.e., large and small, growth and value and virtually all industries. Similarly, your bond holdings should generally reflect the makeup of the bond market overall.

I'd be cautious, however, about cluttering up my portfolio by trying to cover too many bases. A lot of the asset allocation advice I see being offered these days seems little more than a knee-jerk reaction to what happened last year (i.e., stocks got hammered) or an attempt to create a portfolio that will do well if a specific economic scenario unfolds in the future (inflation, deflation, whatever).

My take on asset allocation is that the more complicated you make it, the harder it is to manage your portfolio and the more chances there are to screw up. So I'm an advocate of keeping it relatively simple.

I also view asset allocation as a way to deal with the inherent uncertainty of the markets. Tailoring portfolio allocations to capitalize on a particular economic or market forecast implies one knows what the future holds. If that's the case -- i.e., there's no uncertainty -- then why not just load up on the assets that will thrive in a particular scenario rather than spreading your money around?

Fix your mix

All of which is to say that, initially at least, I'd focus on making sure I have a broadly diversified portfolio of stock and bond funds (which would ideally include foreign stock holdings).

You can get such a mix in one fund if your 401(k) offers target-date funds, as many company plans do. These funds aren't perfect and you need to know what you're getting into before you choose one. But they can be a good choice for someone who doesn't want to build a portfolio on his or her own.

Or you can put together a portfolio on your own by mixing and matching the choices on your 401(k)'s menu. For an idea of what specific types of stock and bond funds you might consider, as well as the percentage you might hold of each, I suggest you check out the target-date funds for someone your age offered by T. Rowe Price and Vanguard, both of which made the cut for our Money 70 list of recommended funds. You don't have to duplicate their allocations exactly, but you can use them as a general guide.

Later on, after you've accumulated more assets, you can always consider branching out into more asset classes either inside or outside your 401(k), although, again, I'd exercise caution.

For now, though, you should focus on creating on a stocks-bonds mix that makes sense given your age and your stomach for risk -- then contribute as much as you can to your plan. Because if you stint on the savings part, your 401(k) won't amount to much no matter how wisely you invest your dough.


Have you recently been laid off? Lost most of your retirement or college savings in the stock market? Dealt with the loss of the family breadwinner with no life insurance? If you've been confronted with some challenge during this recession and would like to have an expert review your situation, send us an email and you could be profiled in an upcoming segment on CNN.  To top of page

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