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Is Your 401(k) Plan Too Conservative? Here’s How you May Fix It

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A 401(k) plan is a retirement savings account offered by most employers that allows employees to contribute a portion of their salary to a 401(k) account. While a 401(k) plan can be a valuable tool for building wealth, you need to assess carefully if your investments are overly conservative or not. A conservative investment portfolio has lower growth potential and may not provide sufficient returns to meet your retirement needs. Additionally, a conservative 401(k) can be a problem if you aim to retire early or wish to live luxuriously in retirement. If you're concerned that your 401(k) plan is too conservative, it's important to identify the issue and take steps to fix it. You can consult with a financial advisor who can help assess your financial goals, risk tolerance, etc., and provide guidance on how to adjust your portfolio accordingly to secure your financial future.

This article explains how you can identify and fix a 401(k) plan that is too conservative. Read on to know more.

What is a conservative 401(k) investment?

A conservative 401(k) investment could imply that a large portion of an individual’s 401(k) funds has been allocated towards relatively low-risk assets such as bonds or cash equivalents. While these investments may offer safe returns, they often fail to keep pace with inflation, which can erode the purchasing power of an individual’s money over time. As a result, a conservative 401(k) portfolio may not provide sufficient growth to meet retirement goals or build wealth. There are a number of ways to identify if you have a conservative retirement portfolio.

How to identify if you have a conservative 401(k)

While you contribute every month to your 401(k) plan, you may observe that your returns may not be growing beyond a certain level. This may indicate that you have a conservative 401k plan. However, before concluding that you have a conservative retirement portfolio, you must observe the growth of the investments for a substantial period, say, a few years at the least.

Let’s read some common signs that indicate you have a conservative 401(k):

1. Access to limited range of investments:

A conservative 401(k) portfolio typically has a limited range of investments, such as stocks, bonds, and cash equivalents. In fact, a majority of such portfolios may have higher exposure to bonds. Further, such portfolios may not include high-risk, high-return investments like international stocks, commodities, or real estate.

2. Lower volatility:

Conservative portfolios tend to have lower volatility, which means they may not experience as much fluctuation in value. It is because such portfolios prioritize preserving capital over maximizing returns. This means they may provide less return on investment than other aggressive portfolios.

3. Heavy allocation to bonds:

A 401(k) portfolio that is heavily weighted towards bonds may be considered conservative. This is because bonds tend to be less risky than stocks and offer a more stable income stream.

4. Limited exposure to emerging markets:

A conservative 401(k) portfolio may have limited exposure to emerging markets, which tend to be more volatile and carry higher risk. This can greatly impact the return-making capacity of the portfolio.

5. Fewer actively managed funds:

Conservative portfolios may have a higher proportion of passively managed funds, such as index funds (which track the performance of a particular market or index). This is because of the low-risk they carry. Actively managed funds that try to outperform the market and are risky may not find allocation in risk-averse portfolios.

6. Higher allocation to cash:

A 401(k) portfolio with a higher allocation to cash, or money market funds, may be considered conservative. It can be great for emergencies and maintaining liquidity but could be eating away at the potential of a portfolio to generate returns.

That said, there is no one-size-fits-all approach to investing, and what is considered a conservative portfolio will vary from person to person. It’s important to consider your own financial goals, risk tolerance, and investment horizon when deciding on the appropriate level of conservatism for your 401(k) portfolio.

Also see: 5 Signs To Know If Your 401(k) Allocation Is Too Aggressive


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What are the disadvantages of a conservative 401(k) plan?

You could be at a significant disadvantage if you are running a conservative 401(k) account. The disadvantages of a conservative plan are as follows:

1. Lower potential for growth:

Since conservative portfolios prioritize capital safety over returns, they afford reduced growth in comparison to aggressive portfolios which offer higher potential for growth. In other words, a conservative 401(k) portfolio could make it harder to achieve long-term financial goals.

2. Missed opportunities for higher returns:

By investing in more conservative assets, conservative portfolios may miss out on the potential for higher returns. This could be more prominent in markets where riskier investments perform well.

3. Greater impact of inflation:

Inflation can eat away your returns. Since conservative portfolios usually record stunted growth, they may not be able to keep pace with inflation. This could lead to diminished returns, resulting in lower retirement savings.

Also see: What Happens if My 401(k) Retirement Plan Changes?

Fixing your conservative 401(k) plan

If you feel that your 401(k) portfolio is too conservative and not aligned with your financial goals, there are several steps you can take to fix it. Ideally, the first step here would be to review and readjust your asset allocation.

The second step could be to reassess your risk tolerance. If your financial goals and risk tolerance allow for it, consider adding higher-risk investments to your 401(k) portfolio. This could include stocks, commodities, metal, cryptocurrencies, or even real estate. This could be an ideal approach if you are below 40 and are looking for additional returns and diversification. A good example would be target date funds. Here, the fund you choose will maintain a more aggressive portfolio when you are younger and progressively become more conservative as you grow older.

Third, you can use some tried and tested strategies and thumb rules to enhance your 401(k). For instance, some advisors employ the ‘Rule of 100’ to determine asset allocation when concerning stocks and bonds. According to this approach, you subtract your age by 100 to determine your stock allocation, with bonds making up the balance. For instance, a 40-year-old should invest 60% in stocks and 40% in bonds, whereas a 65-year-old should invest 35% in stocks and 65% in bonds.

While this approach may not fit all scenarios, it works fairly well if you are looking to start investing on an aggressive note, and adopt a more conservative approach later. Several experts argue that using the rule of 110 or 120 is better than the rule of 100 as it allows retirees to have a greater proportion of stock funds, ensuring a higher retirement corpus in the future.

If you’re unsure of how to make changes to your conservative 401(k) portfolio to better align with your financial goals and risk tolerance, seeking the advice of a financial advisor can be helpful. These professionals have the expertise to identify portfolio issues and can help strike a good balance between an aggressive and conservative 401(k) plan.

To conclude

A conservative 401(k) investment portfolio may display limited growth when compared to a more aggressive portfolio. You may also miss out on opportunities to generate higher returns and may be unable to counteract the impact of inflation. If you feel that your 401(k) portfolio is too conservative, there are several steps you can take to fix it, such as reviewing your financial goals and risk tolerance, diversifying your portfolio, adding more aggressive investments, and readjusting your asset allocation. It’s important to carefully consider your financial goals, risk tolerance, and investment horizon before making any changes to your 401(k) portfolio.

If you’re unsure of how to diversify your portfolio, consider hiring a financial advisor that can help. Use the free advisor match tool to match with experienced financial advisors who can guide you effectively on portfolio rebalancing. Answer a few questions based on your financial needs, and the match tool will help connect you with 1-3 financial advisors that may be suited to help you.

The blog articles on this website are provided for general educational and informational purposes only, and no content included is intended to be used as financial or legal advice.
A professional financial advisor should be consulted prior to making any investment decisions. Each person's financial situation is unique, and your advisor would be able to provide you with the financial information and advice related to your financial situation.