Hey there, quick tip for you today. I’m going to teach a lesson I learned from my investing mentor, and it will help you maximize your 401k. Let’s get right to it.
So you have your 401k, and hopefully you’re invested in index funds instead of mutual funds. I hope these funds are diversified, for obvious reasons. For simplicity sake, let’s say your 401k looks something like this:
20% – Large Cap Stocks Index Fund
20% – Small Cap Value Stocks Index Fund
20% – International Stocks Index Fund
20% – Bond Index Fund
20% – Junk Bond Index Fund
This portfolio actually would be ideal, because you have good exposure to fixed income and stocks (domestic and international). You’ll be able to capitalize on the volatility of these funds, if you follow this advice.
Every 6 months (or could be every 12 months), you want to examine your 401k portfolio and assess the results. Basically you want to sell the winners and buy the losers. While this may at first seem counterintuitive, it actually makes sense when you think about it.
By cutting your winners and buying the losers, you are effectively buying low and selling high. The truth is that each of the stock funds will be volatile, and you have to understand they will rise and fall over time.
By adding more bonds when stocks are doing good, you are buying less stock. This is good because when stocks are performing well they are very expensive.
On the flip side, when stocks are doing terrible this is exactly the right time to buy them. In this case you are selling some of your bonds to pick up stocks when they are cheap.
So How Do I Do This?
Let’s look again at the example I presented. Let’s say after 6 months the percentages now look like this:
25% – Large Cap Stocks Index Fund
30% – Small Cap Value Stocks Index Fund
25% – International Stocks Index Fund
10% – Bond Index Fund
10% – Junk Bond Index Fund
In this situation stocks have done very well for you, so they now take up a bigger part of your portfolio. What you want to do now is sell each fund that has done well until it is back to the original 20%. With your profits now locked in, you want to use these gains to buy more bond funds so they are back to the original 20% as well.
This process is also known as portfolio rebalancing, and all 401k plans should offer it. Do this regularly, and you will be able to celebrate no matter what the market is doing.
Instead of dreading the market coming down, you now welcome the opportunity to get stocks when they’re cheap. And when the market rises up, you’re securing your profits before they are lost in the wind like everyone else’s.
That’s how you maximize your 401k.
**Maximize Your 401k – Wisdom Wednesdays #18**
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