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According to a recent study from Fidelity, a record number of people will become millionaires thanks to 401(k) investments in 2024. GOBankingRates recently reported that 485,000 new millionaires will be created in the world through 401(k) funds this year.
But not everyone who follows the traditional advice to invest in a 401(k) will achieve this level of wealth, especially if their employer contributes funds. Experts told GOBankingRates that some actions you can take with a 401(k) may be unnecessarily risky. This isn’t to say these investments are bad, but they may be too risky or too conservative to meet your retirement goals.
Experts like Robert Johnson, PhD, CFA, CAIA, professor of finance at Creighton University’s Heider College of Business and co-author of several books, including Investment Banking for Dummies, say many people decide how to allocate their 401(k) contributions early in their careers and then don’t reevaluate those plans as they approach retirement age.
“Too often, individuals become overly conservative in their asset allocation,” he said. “Behavioral research shows that inertia sets in and people are hesitant to change their initial allocations. This leads to large opportunity costs over time and compound interest. Individuals need to be taught to invest, not save, for retirement.”
He noted that large-cap stocks, such as those represented by the S&P 500, have generated a 10.1% return between 1926 and 2022, according to data compiled by Ibbotson Associates. While it’s good to maintain a diversified portfolio, experts said you should not have more than 5% of your 401(k) portfolio in the following investment classes to balance growth and risk:
Treasury bills or treasury bills
Johnson warned that while typical large-cap stocks have returned more than 10%, long-term government bonds have returned just 5.2% a year. Similarly, short-term Treasury bills have returned 3.2% a year, he said.
While it’s fine to have a small percentage of your money in such funds to balance out riskier investments, Johnson points out the old adage: “Whether you sleep well or eat well is up to you.”
“If you put your money in low-risk investments like money market funds or Treasury bills, you’ll sleep well, but your investment won’t grow much and it may have a hard time keeping up with inflation. If you invest consistently in stocks, you’ll live comfortably,” he said.
Invest aggressively to grow your account, especially while you’re young. If you make a mistake, you still have decades until retirement and time to rebuild your wealth. “People with a long-term horizon shouldn’t invest in money market instruments, but many do so out of fear of stock market volatility.”
Master Limited Partnership
Some 401(k) plans offer the opportunity to invest in master limited partnerships (MLPs), which are publicly traded companies that typically focus on real estate or natural resources. MLPs offer tax-deferred distributions and other tax benefits. But they’re complex investments that could have unexpected consequences at tax time, says Stephen Kates, CFP and principal financial analyst at RetireGuide.com.
“MLPs can offer attractive yields that attract income-focused investors, but they have unique factors that make them difficult to own. Unlike most regular stocks, any income over $1,000 earned from an MLP is taxable, even in a retirement account,” he explained.
Company Stocks
Some companies offer employee incentives to buy company stock in brokerage accounts or 401(k) plans, and many offer matching stock. “This may seem like a good idea because you know the company well and trust it enough to work there,” Cates says. “But given that you’re already invested in the company through your employment, further concentration through stock ownership may be too risky…. That’s why it’s important to not only maintain a diversified portfolio, but also to maintain a diversified portfolio outside of your employment or industry expertise.”
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