4 Ways To Manage Your Finances If All You Have Is A 401(k)

A crash course...

by Stephanie Leone

Congratulations — you have a 401(k)! You've selected a contribution, which your employer may match, and that’s about the extent of your knowledge. It’s understandable: The stock market and its myriad features are confusing to navigate, and isn’t the point of a 401(k) that others handle everything for you?

Technically, no. With a 401(k) you’re in charge. Choosing how much to save and how to invest are key decisions that will determine how much you’ll have in retirement. A 401(k) is a great way to start saving for retirement automatically. Getting invested early, contributing at least up to any employer match (you probably need to do more), and staying invested will help put you on the right track to reaching your financial goals. That’s advice straight from Charles Schwab's personal financial expert, Carrie Schwab-Pomerantz CFP®. From establishing a money market savings account, to investing in property or stocks, her Ask Carrie columns are full of tips to help you grow your money, whether you're saving for retirement, a new home, or your next vacation.

Dive into her lifetime of financial experience and build your own financial health and education with these simple, effective strategies. Additionally, learn everything you need to know about your finances from Schwab-Pomerantz's Ask Carrie column. You'll be so glad you did.

1. The Best Investment Strategy Is (Still) Asset Allocation And Diversification

The first thing to know about asset allocation and diversification is that they’re two halves of a whole, but there is a difference. Asset allocation refers to how you divide your money among major investment categories, like stocks (aka equities), bonds, cash, and other types of investments. Stocks have the highest return potential, but they can also carry the highest short-term risk. On the other end of the spectrum, cash investments generally won’t grow quickly. They also tend to carry the lowest risk. Bonds can fall somewhere in between the two. Once you assess how much risk you’re willing to take and how much time you have to invest, you can determine which percentage of your investment will go into these options. If you’ve got only a little to spare though, Carrie has a recommendation. “Any money you'll need within the next three to five years should be kept in lower risk investments.”

That’s where diversification comes into play. By spreading your money between different types of investments within each asset class, you’re better-positioned to weather inevitable market storms. Instead of just one stock or bond, ideally you would have many. You can zoom in on types of stocks: large cap, small cap or international. Zoning in even further, you’d do well to invest in different sectors — such as technology, healthcare, or telecommunications — which will help you diversify further. You can take a similar approach when investing in bonds.

Most 401(k) plans use mutual funds as the primary way for you to help you allocate and diversify. A mutual fund is an investment vehicle made up of a pool of money from many investors that buys equities, bonds and other securities. When you buy a mutual fund, you get exposure to all the investments in that fund. Mutual funds make it easy to build a diversified portfolio and get professional management, so you don’t have to research, buy, and track every security in the fund.

By diversifying or spreading your money between different types of investments within a mutual fund, you’re better-positioned to weather inevitable market storms. Instead of just one stock or bond, you would have dozens if not hundreds or thousands of holdings to avoid putting all of your eggs in one basket. You may be able to zoom in on types of fund categories including large cap, small cap, or international. Zoning in even further, you may be spread your investment bets across different sectors — such as technology, healthcare, or telecommunications — which can help you diversify further. You can take a similar approach when investing in bonds.

You can diversify widely by using several funds or even a single fund — like a target date or balanced fund that is professionally managed for a specific investment objective.

To invest in a wider array of investments beyond the preselected investment fund lineup of your plan, some 401(k)s offer plan participants a “brokerage window” that allow increased choices across a wider range of asset classes through individual stocks, bonds, mutual funds, ETFs and other investment products. Keep in mind that using a self-directed brokerage window requires more time more research on your end and may lead to taking increased risks.

2. The Market Is Always Changing — Be Prepared

Diversification is a risk management strategy. It simply means that you’re not taking on too much risk by concentrating your investments into something that may not work out. Diversification has no guarantee against market losses, but it helps you from taking on too much risk. While the stock market historically has increased in value over time — and is likely to do so over the long haul in the future — no one can predict what will happen in the stock market particularly over short periods of time. The future will always be uncertain.

“The good news,” says Carrie, “is that even though some points of execution have been fine-tuned, the fundamental principles of asset allocation and diversification remain the best ways to control risk.” Having a plan goes hand in hand with asset diversification and allocation. In fact, market volatility only increases their importance.

3. Take Ownership Of Your Money

Once you’ve done the work to invest, there’s a lot you can’t predict or control. What you can know in advance are the costs of investing, that’s why it’s always important to understand fees and costs whenever you invest. Remember, paying more doesn’t always get you more when it comes to investing. What you can control is how well you know your portfolio, and how you respond to the market. Most financial experts recommend reviewing and rebalancing your portfolio annually, but in times with increased volatility— like COVID-19 — you may want to do this quarterly. Another rebalancing strategy is to make changes if your portfolio allocation shifts beyond five percent of your target allocation. Bottom line is that sticking with your overall strategic allocation plan and rebalancing whenever it gets out of whack is generally more important than having a set frequency for when you rebalance.

As far as how frequently you check your portfolio, try and line up your “look interval” with when you’re going to use the money. With a balanced portfolio that is aligned with your risk tolerance and time horizon, you shouldn’t have to be constantly checking your investments.

Carrie reminds us that it's never a good idea to try to “time the market,” but that doesn’t mean investors can’t make small, tactical changes in attempts to take advantage of market opportunities or to try to minimize losses. “This doesn’t mean that you'd move in and out of the market all together,” she says, “but rather rebalance and make small shifts to respond to changing market conditions.”

Many financial service companies offer services that can help you achieve the right balance. These services are typically designed to help you build, monitor, and maintain your investments with ongoing personalized advice at an additional cost. Check with your 401(k) provider to see if your plan offers this type of service if you’re interested.

4. Make Sure You Still Have An Your Emergency Fund

A 401(k) is designed specifically for your retirement. While there may be ways to access the money for something else if you’re in a pinch, it could be a costly option when you factor in potential taxes and penalties. Additionally, it could take days or weeks for you to receive the funds. This is why you should always have a separate rainy-day fund for emergencies and should never look at your 401(k) as an ATM.

The most important functions of an emergency fund should be safety and liquidity. Safety since you want the money to be there when you need it, and liquidity so you can quickly access your money. You can use an interest-bearing checking account, which allows you to write checks and have easy ATM access to your cash. By contrast, a savings account tends to pay more interest than checking accounts, but your withdrawals are limited.

A money market deposit account through a bank — a higher-yielding savings account that may offer limited check writing privileges — generally provides higher yields than a checking account. And, finally, If you can part with your cash with certainty for a longer period of time, a short-term certificate of deposit (CD) offers higher yields the longer its allowed to mature. Because penalties usually apply if you withdraw early, CDs aren’t recommended unless you can afford to leave the money alone until the CD matures. It’s a good idea to target 3-6 months of essential expenses in an emergency fund.

Most importantly, Carrie reminds each of us to take a step back and review our total financial landscape before making a decision. “Take a look at the various accounts you have set up for specific goals. Different accounts will have varying rules for withdrawals as well as different tax implications. With this big picture in mind, you’ll be in better shape to make the best decisions.”

This article is sponsored by Charles Schwab. Visit Ask Carrie to help you on your way to achieving your own money goals in the future. The information provided here is for general informational purposes only and is not intended to be a substitute for specific individualized tax, legal or investment planning advice. Where specific advice is necessary or appropriate, consult with a qualified tax advisor, CPA, financial planner or investment manager.

Brokerage Products: Not FDIC-Insured · No Bank Guarantee · May Lose Value

Diversification, asset allocation, and rebalancing strategies do not ensure a profit and do not protect against losses in declining markets. Rebalancing may cause investors to incur transaction costs and, when a nonretirement account is rebalanced, taxable events may be created that may affect your tax liability.

Investing involves risk, including loss of principal.

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