How Aggressive Should Your 401(k) Be?

With more responsibility for saving for retirement resting on the individual, striking the right balance is more critical than ever.

by Aaron Crowe - September 18, 2017

The proliferation of 401(k) retirement accounts, combined with the large reduction in companies offering pensions, dramatically changed the way Americans save for retirement. Instead of relying on employers to fund their retirement, workers are more responsible for their own savings. The upside is that they also gained a say in how much they contribute and how their money is invested.

The number of active participants in defined contribution plans, which include 401(k)s, was 73.7 million in the U.S. in 2014, according to the U.S. Department of Labor, nearly double the number from 1992. Over the same time period, the number of participants in defined benefit plans, such as pensions, was essentially unchanged at around 39.5 million people.

With so much responsibility in their hands with a 401(k), employees now have to make strategic decisions, including determining how aggressive they can afford to be in building retirement savings.

Consider long-term aggressiveness

Being aggressive may pay off for 401(k) participants who invest in more stocks than bonds, says Drew Denning, Senior Vice President – Retirement Strategist with Wells Fargo Advisors in St. Louis. But investors who are within five to 10 years of retiring may want to act more conservatively, because that 401(k) is money they’ll need to tap into in the near term and don’t want to lose it, he adds.

Denning points to some numbers to show the impact of trending aggressively. According to an analysis of the market done by Wells Fargo Advisors*, the 20-year mean total return on a balanced, conservative allocation of 60% U.S. bonds and 40% U.S. stocks from 1976 to 1996 was 7.6%. That figure rises to 8% when you reverse the balance, with 40% bonds and 60% stocks.

And while that difference may not seem like much, a rapidly rising or falling stock market can dramatically affect returns in one year. In 2012, the same balanced, conservative allocation had a return of 8.9%, while the balanced aggressive allocation had an 11.3% return. But in 2008, being aggressive would have lost you 20.2%, while the conservative route would have resulted in a loss of 11.7%.

“Investment choices in a 401(k) can be heavily influenced by risk tolerance, but age should also be a factor.”

— Drew Denning, Senior Vice President – Retirement Strategist, Wells Fargo Advisors

Take age into your analysis

Investment choices in a 401(k) can be heavily influenced by risk tolerance, but age should also be a factor, Denning says. People nearing retirement may want to make up some ground by being aggressive investors, but a falling stock market can greatly reduce what they already have, he says.

The time to be more aggressive, he says, is when you’re more than 15 years from retirement. At 10 to 15 years until retirement, a common recommendation is to be 60% or 70% in stocks and 40% or 30% in bonds, Denning says. Generally speaking, cut back equity investments 5% every five years, he says, and monitor asset allocation every three years.

“As people get older, they should be a little more conservative with asset allocation,” he says.

Be aggressive with early contributions

An easy way to be aggressive with a 401(k) outside of your asset breakdown is to invest what you can early in your career — at least enough to reach an employer match, says Denning, who recommends the 15-40-85 method. That means saving 15% of your income for 40 years, which should give you enough money at retirement to live on 85% of your preretirement income. As retirements increase in length, however, and depending on what you want your retirement to look like, your numbers may vary. Your Financial Advisor can help you determine what you need to save, even early on.

Many employers — 70% to 80% — match employee 401(k) contributions, Denning says. Historically, those matches most often have been dollar for dollar, he says, up to 4% of their salary. But just investing up to that level of employer match only gets workers to an 8% contribution.

Some employers have tried to help encourage their workers to save more by offering a 50% match for employees who contribute up to 8% of their salary. And, in general, people are saving more. Denning says the current average employee contribution is about 7.6% of salary. But most workers still fall short of annual contribution limits, which are $18,000 for 2017 ($24,000 for 401(k) contributors over age 50).

“People are not saving nearly enough for the type of retirement that they’re expecting,” he says. “The biggest lever they can pull is increasing their contribution rate.”

Aaron Crowe is a freelance journalist who specializes in personal finance writing. He writes for a variety of websites, including his personal finance blog.

Image by Thinkstock

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*Calendar years from 1976-2012 using MSCI USA Stock & Barclay’s Aggregate US Bonds. Assumes tax deferred or tax-exempt account standard deviation based on annual returns.

The indices are presented to provide you with an understanding of their historic long-term performance and are not presented to illustrate the performance of any security. Investors cannot directly purchase any index.