Choosing 401(k) investments

While a 401(k) plan doesn't usually let you choose among all the investments available in the marketplace — which can be a good thing if you're uneasy about making investment decisions — you will have a range of selections from which to create your account portfolio. You'll probably be able to choose from a variety of mutual funds, stable value funds, guaranteed investment contracts (GICs), annuities and, sometimes, individual stocks and bonds.

One of the things that will influence the investment selections you make is how much risk you're willing to take with your retirement plan account. Any investments that aren't guaranteed or insured expose you to the possibility of losing principal, especially in a market downturn when investments of all or many classes tend to lose value. 

On the other hand, being willing to take some risk with at least a portion of your account value increases the possibility of a stronger return and greater progress toward your financial goals. And, of course, the more time you have until you plan to retire, the more risk you can afford to take. You may want to talk with an investment adviser as you make these decisions.

Seeking diversification

One advantage of mutual funds is that they offer instant diversification. That's the case because most mutual funds make investments in dozens of companies. For example, instead of holding 1,000 shares of one stock, a stock mutual fund might own shares in 100 different stocks. Even if some of those 100 stocks lose value at some point while the fund owns them, others are likely to hold their own or increase in value.

Diversification is important because it can help you achieve nearly the same level of return that you would have had by owning only the strongest performing investments in any one period while reducing the risk of losing money. The risk is reduced because you'll never own only the weakest performing investments in that same period.

Mutual fund choices

Each mutual fund has a specific investment goal and investment style, tailored to meet the needs of a particular type of investor. While a 401(k) plan usually offers a limited number of funds, you may be able to choose some mutual funds that focus on growth, others that seek income, and some that do both by investing in both stocks and bonds. For most people, spreading assets among several funds with varying goals and styles is a good idea.

Company stock

You might be able to add shares of your employer's stock to your 401(k) or your employer may make matching contributions in stock. While the stock may be a solid investment, you should be wary of concentrating too much of your portfolio in one investment, since a drop in price could have a strong negative affect on your savings.

In fact, it's usually a good idea to keep no more than 10% of your 401(k) assets in your company's stock. And you're already dependent on the company for your salary, so if the worst happened and the company failed, you'd lose your retirement savings as well as your current income. You may also want to consider a similar guideline for shares of your employer's stock that you might hold in other accounts.