10 Ways to Turbocharge Your 401(k)
Reprinted courtesy of MarketWatch.com
To read the original article click here.
Last week I outlined four ways to make your 401(k) or other retirement savings work harder for you, in the first installment of my list of 21 things you can do to improve your financial future.
This week I’ll give you 10 more. Each is valuable; together, they can change your life.
These suggestions are all about the equity asset classes that I believe will make your money work harder for you without additional risk. That claim is often made on Wall Street. But I’m backing it up with half a century of academic research.
I hope you’ll remember that most investors, once they reach a certain age, should have some of their retirement savings in bond funds. That’s a separate (and very important) issue. This column is all about equities. They are the engine that will drive your returns over the years.
So let’s crank up the starter motor and go!
One: Invest in the Standard & Poor’s 500 Index SPX +0.67% . (Every asset class in this list is available in an index fund.) Comprising the largest companies in the U.S., this index is widely regarded as “the market” and a tough benchmark to beat. It should be part — but only a part — of your equity investments.
In the 50 years from 1963 through last December, this index returned 9.8% per year. Remember that number, because it’s the benchmark to beat.
Two: Invest in U.S. large-cap value stocks. These are stocks that for various reasons are out of favor with most investors. Because they are unloved, in many cases they are bargains. From 1963 through 2012, an index of U.S. large-cap value stocks returned 10.9%.
Three: Invest in U.S. small-cap stocks. Smaller companies have potential to grow much faster than large ones. Microsoft, Google, Intel, Apple and even General Electric all began as small companies. Somewhere right now there’s a very small and virtually unknown company that, eight or 10 years from now, will be among the giants. If you buy a small-cap fund, you will be able to say that you owned that stock “way back when.”
From 1963 through 2012, an index of U.S. small-cap stocks returned 12.4%.
Four: Invest in U.S. small-cap value stocks. This asset class combines the advantages of small and value that we just discussed, and it has a terrific long-term record. From 1963 through 2012, an index of U.S. small-cap value stocks returned 15%.
Five: Invest in U.S. real estate stocks (REITs). REITs are a bit like mutual funds that own commercial real estate of all kinds. They aren’t suitable for accounts subject to taxes, but they are ideal for 401(k) plans and IRAs.
From 1978 through 2013 (the longest period for which I have data), an index of REITs returned 12.5%, versus 11.2% for the S&P 500 Index.
Six: Invest in international large-cap stocks. An index known as EAFE is the international equivalent of the Standard & Poor’s 500 Index in the United States. In the 43 years from 1970 through 2012, this asset class returned 9.1%. While that’s lower than its U.S. counterpart, this asset class provides valuable diversification, and in many calendar years it has outpaced the S&P 500 Index.
Seven: Invest in international large-cap value stocks. This asset class has the same attributes as its U.S. counterpart, discussed above, and it has done even better. From 1975 through 2012, international large-cap value stocks returned 14.8% versus 11.6% for the S&P 500 Index.
Eight: Invest in international small-cap stocks. The story is the same internationally as in the United States. From 1970 through 2012, this asset class returned 14.4% versus 9.9% for the S&P 500 Index.
Nine: Invest in international small-cap value stocks. It’s safe to assume that you’ve never heard of most of the stocks in this category, but it’s equally safe to predict that some of them will thrive. Investors who have owned the asset class have done well. From 1982 through 2012, international small-cap value stocks returned 14.1%, compared with 11.2% for the S&P 500 Index.
Ten: Invest in emerging markets stocks. These stocks may seem risky, but they have explosive growth potential. Having this asset class working for you makes good sense as long as it’s only a small slice.
From 1988 through 2012, emerging markets stocks returned 12.9% versus 9.8% for the S&P 500 Index.
Over all the periods in these comparisons, nine asset classes bested the S&P 500 Index by an average of 2.6 percentage points a year. Over time, that extra return can let investors retire earlier instead of later, live well instead of pinching pennies.
Even better: A study going back to 1970 found that a balanced portfolio of all these asset classes had virtually the same risk as the S&P 500 Index alone.
I encourage you to read a great article about putting these asset classes together. Next week I’ll tell you exactly how to do it.
Richard Buck contributed to this article.