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I am a new grad and I just started working for a company. They offered me a 401(k) with a very good matching. So I decided to invest some of my income as I am single. I was taken by surprise by how I have to split my 401(k) funds on various stocks. So, does that mean I could end up with nothing if things go wrong somewhere? What are the strategies that I should do, provided I will not retire for another 35 years(long term investment). Also, when I split funds what are the risk factors I have and where should I look for to determine whether this fund is suitable for me or not. Thanks.

  • 'various stocks' - how many choices do you have? Is it a number of funds that fit into simple categories? Is there a choice for individual stocks or just the company stock? – JoeTaxpayer Apr 9 '13 at 17:39
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You could end up with nothing, yes. I imagine those that worked at Enron years ago if their 401(k) was all in company stock would have ended up with nothing to give an example here. However, more likely is for you to end up with less than you thought as you see other choices as being better that with the benefit of hindsight you wish you had made different choices.

The strategies will vary as some people will want something similar to a "set it and forget it" kind of investment and there may be fund choices where a fund has a targeted retirement date some years out into the future. These can be useful for people that don't want to do a lot of research and spend time deciding amongst various choices. Other people may prefer something a bit more active. In this case, you have to determine how much work do you want to do, do you want to review fund reviews on places like Morningstar, and do periodic reviews of your investments, etc. What works best for you is for you to resolve for yourself.

As for risks, here are a few possible categories:

  1. Time - How many hours a week do you want to spend on this? How much time learning this do you want to do in the beginning? While this does apply to everyone, you have to figure out for yourself how much of a cost do you want to take here.

  2. Volatility - Some investments may fluctuate in value and this can cause issues for some people as it may change more than they would like. For example, if you invest rather aggressively, there may be times where you could have a -50% return in a year and that isn't really acceptable to some people.

  3. Inflation - Similarly to those investments that vary wildly there is also the risk that with time, prices generally rise and thus there is something to be said for the purchasing power of your investment. If you want to consider this in more detail consider what $1,000,000 would have bought 30 years ago compared to now.

  4. Currency risk - Some investments may be in other currencies and thus there is a risk of how different denominations may impact a return.

  5. Fees - How much do your fund's charge in the form of annual expense ratio? Are you aware of the charges being taken to manage your money here?

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Ending up with nothing is an unlikely situation unless you invest 100% in a company stock and the company goes under.

In order to give you a good answer we need to see what options your employer gives for 401k investments.

The best advice would be to take a list of all options that your employer allows and talk with a financial advisor.

Here are a few options that you may or may not have as an option from an employer:

  • Target date retirement funds
  • Index funds
  • ETFs
  • Individual Stocks

Definitions from wikipedia:

  1. A target-date fund – also known as a lifecycle, dynamic-risk or age-based fund – is a collective investment scheme, usually a mutual fund, designed to provide a simple investment solution through a portfolio whose asset allocation mix becomes more conservative as the target date (usually retirement) approaches.

  2. An index fund or index tracker is a collective investment scheme (usually a mutual fund or exchange-traded fund) that aims to replicate the movements of an index of a specific financial market...

  3. An exchange-traded fund (ETF) is an investment fund traded on stock exchanges, much like stocks.[1] An ETF holds assets such as stocks, commodities, or bonds, and trades close to its net asset value over the course of the trading day. Most ETFs track an index, such as a stock index or bond index. ETFs may be attractive as investments because of their low costs, tax efficiency, and stock-like features.

  4. The capital stock (or stock) of an incorporated business constitutes the equity stake of its owners.

Which one can you lose everything in?

You can lose everything in stocks by the company going under.

In Index funds the entire market that it follows would have to collapse. The chances are slim here since the index made up of several companies.

The S&P 500 is made up of 500 leading companies publicly traded in the U.S. A Pacific-Europe index such as MSCI EAFE Index is made up of 907 companies.

The chances of losing everything in an ETF are also slim. The ETF that follows the S&P 500 is made up of 500 companies. An Pacific-Europe ETF such as MSCI EAFE ETF is made up of 871 companies.

Target date funds are also slim to lose everything. Target date funds are made up of several companies like indexes and etfs and also mix in bonds and other investments depending on your age.

What would I recommend?

I would recommend the Index funds and/or ETFs that have the lowest fee that make up the following strategy for your age:

  • 70% S&P 500
  • 20% Pacific-Europe
  • 10% Emerging Markets

Why Not Target Date Funds or Stocks?

Target date funds have high fees. Later in life when you are closer to retirement you may want to add bonds to your portfolio. At that time if this is the only option to add bonds then you can change your elections.

Stocks are too risky for you with your current knowledge. If your company matches by buying their stock you may want to consider reallocating that stock at certain points to your Index funds or ETFs.

  • The Vanguard target retirement date funds (e.g. 2050: VFIFX) have low expenses, ≤0.18%. – Craig W May 20 '13 at 23:49

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