Simplifying 401(k) Investment Decisions

Deciding how to invest your 401(k) (or other retirement accounts) can feel overwhelming, but it doesn’t have to be.

Concepts like exponential growth and market volatility aren’t always intuitive, and behavioral biases can make it challenging to save and stay invested during downturns. Below, we’ve outlined some key ideas and strategies to help simplify your decision-making process.

And remember, Evermay Wealth Management is here to help apply these ideas to your unique retirement plan – give your Evermay team a call today to schedule an appointment.

Investing Is Time Travelling

Investing starts with saving today for a future goal. Two key factors to consider when deciding how to invest your money are your time horizon and risk tolerance.

Time Horizon

Your time horizon is how long you will stay invested for your financial goal. For very short-term goals, like saving for a tax bill in three months, the investment approach is straightforward: keep the funds in cash or another low-risk investment to ensure it’s available when needed.

Saving for retirement, however, is more complex, as you must meet financial goals over a long period of time – perhaps decades. Thinking about retirement investments as having multiple time horizons can be helpful. Let’s say you are starting your first job at age 25. If you expect to live to age 95, your first retirement contribution might have a time horizon of 70 years. If you intend to retire at age 67, you’ll make contributions over 42 years of employment, with each subsequent contribution having a shorter time horizon until it’s needed in retirement.

Here’s why that’s important for those currently in the process of building retirement savings: your portfolio at retirement will be the combination of your current and your future investments. Between these, your current investments have the longest potential time horizon. It can be illuminating to compare the size of your portfolio with your future expected contributions, a planning exercise your Evermay Wealth Advisor can help you evaluate.

Once in retirement, you’ll need to consider both immediate- and long-term goals from your basic needs to your highest aspirations. Other factors that can impact your investment  time horizons in retirement include your Social Security benefits, pensions, taxable savings, and potential inheritances. A clear understanding of your time horizons can help determine how to allocate your investments at various stages of your life.

Risk Tolerance

Risk tolerance reflects how comfortable you are with market ups and downs. Imagine again setting aside money for an upcoming tax payment. If you invest that money in the stock market instead of holding it in cash, you’d risk short-term losses and possibly not having enough money to pay the tax bill. To manage that risk, you’d either need to set aside more than required or adjust other financial goals if the market didn’t cooperate.

The same applies to your retirement portfolio.  At the risk of oversimplifying, let’s consider a portfolio that combines only two investments, stocks and bonds. Stocks tend to offer higher returns over time but can be more volatile in the short term, while bonds are normally less volatile but with lower expected returns. This volatility can cause significantly lower performance in stocks in the short term.

Over time, however, the difference narrows. Thus, for a given risk tolerance, the longer your time horizon the more you can allocate to stocks, as their higher potential expected long-term return makes them more likely to eventually recover from short-term losses. A good financial plan will illustrate this tradeoff between risk and return, allowing you to compare the expected returns of different asset allocations with the chances of poor outcomes, helping to guide your investment decision.

Staying the Course

Even with a solid plan, market fluctuations can test your resolve. Research shows that people feel the impact of losses about twice as much as gains (Tversky & Kahneman, 1992). That can lead investors to make emotional investment decisions that reduce long-term returns—Morningstar estimates the average investor underperformed by 15% over the ten years through 2023 from poorly timed changes to their investments (Ptak, 2024).

The best investment strategy is one you can stick with in good times and bad. Finding the right balance between long-term growth and your comfort level helps you ride out market swings.

Saving More (Tomorrow)

Saving for retirement can feel like sacrificing today’s comforts. One smart approach, called “Save More Tomorrow,” involves committing to gradual savings increases—like tying them to annual raises. This lets you save more over time without cutting into your current budget.

Many 401(k) plans now feature automatic escalations designed to periodically increase an employee’s contribution rate in a similar manner.

Simplifying Investment Choices

The number of investment options in a 401(k) plan can sometimes overwhelm investors, leading to suboptimal decisions – some as extreme as not participating at all. For example, one study found participation in 401(k) plans declines as the number of investment options increases (Iyengar et al. 2004).

Focusing on time horizon, risk tolerance, and maintaining discipline can help you achieve your retirement goals. And with a little help from strategies like "Save More Tomorrow" or automatic escalation, you might find the process easier than you think.

At Evermay, we specialize in guiding clients through these decisions. Whether it’s determining the right mix of investments or crafting a strategy that aligns with your goals, we’re here to help. Let’s discuss your 401(k) or other retirement plan at our next meeting together—we’d love to walk through these concepts and more with you.