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401(k) Allocation Model

401(k) Allocation Model

Employer-sponsored 401(k) plans are one of the most popular ways to save for retirement. But unfortunately, very few investors realize the full potential of these plans because they neglect to monitor and update their investments as conditions change.

Instead of taking an active role, most 401(k) investors assume that they can simply choose a fund, set up a contribution amount, and their retirement will grow on autopilot. However, this is not the case. All plans encourage workers to update their allocations frequently, but few take the time to do this, and even fewer know how to do this strategically.

Model Investing recommends that you review and adjust your 401(k) allocations on at least a quarterly basis. This frequency will allow you to successfully adapt to changing financial conditions, taking full advantage of growth opportunities while also avoiding major losses during severe market downturns. To help you accomplish this, we’ve developed the 401(k) Allocation Model, otherwise known as the 401 Model.

Find Out How to Use the 401 Model to Manage Your 401K

The 401 Model is designed to keep your retirement funds allocated to the strongest performing areas of the market, while still maintaining adequate diversification. Like all of our investment models, the 401 Model contains a built-in mechanism for moving to a position of safety during severe market declines.

The chart below shows the backtested performance of the 401 Model over the last 23 years. For comparison, the performance of SPY (an index fund that tracks the performance of the S&P 500), AGG (an index fund that tracks the Barclays U.S. Aggregate Bond Index), and a 60/40 blend of those two funds are included in the chart. Make sure to read this entire page to understand how the results below were achieved, and how you can apply these results to your own portfolio.

401(k) Allocation Model
Model performance represents total returns and includes reinvestment of dividends and interest. No management fees or transaction costs are included. Historical performance is not an indication or guarantee of future performance.

Notice that the 401 Model was able to largely avoid the losses associated with the dot-com collapse and financial crisis, while also growing significantly faster than portfolios comprised of entirely stocks, bonds, and a 60/40 blend of stocks and bonds. This outperformance is achieved by dynamically reallocating investments into the top performing areas of the market as conditions change.

Not only was the 401 Model able to outperform various allocation strategies, as well as the broader market, it did so with less portfolio volatility and overall risk. The table below contains a series of performance metrics that allow you to compare the 401 Model against several benchmarks.

401 Model Performance Metrics
Strategy Compound Annual Return Alpha1 Beta1 Standard Deviation Maximum Drawdown Sharpe Ratio Sortino Ratio Treynor Ratio
401 Model 10.06% 6.35% 0.43 11.68% -22.91% 0.78 1.84 0.21
SPY (S&P 500) 6.18% 0.00% 1.00 18.29% -50.81% 0.34 0.39 0.06
AGG (Bonds) 3.78% N/A 0.01 5.03% -17.13% 0.46 0.61 1.73
60/40 Stocks/Bonds 5.36% 0.91% 0.53 9.88% -23.87% 0.43 0.51 0.08
Data for 23-Year Period (2000 – 2022)           1 Benchmarked against the S&P 500

Key Performance Highlights:

  • Over the last 23 years the 401 Model’s compound annual return has significantly outpaced that of both stocks and bonds, as well as a blended portfolio.
  • When compared to stocks, the 401 Model generates strong excess returns (alpha) while experiencing significantly less volatility (risk).
  • The reduced volatility and enhanced returns provide for notably higher risk-adjusted returns, as evidenced by the Sharpe, Sortino and Treynor ratios, and a positive alpha.
  • Stocks lost over half their value during the financial crisis. The 401 Model was able to sidestep those losses by repositioning the portfolio into bonds.

Every 401(k) plan contains a different mix of available funds. However, if you look deeper, you’ll notice that there’s a pattern regarding the types of funds that are offered. In general, most 401(k) plans will offer a variety of stock funds with domestic exposure, a few stock funds with international exposure, a few bond funds, and typically at least one fund that is designed for stable value, representing the safety of having your money in cash.

The 401 Model is designed to be adaptable to all 401(k) plans, but will initially require a small amount of effort on your (or our) part. It is comprised of investable ETFs that relate very closely to funds within your 401(k). The specific funds are listed below.

401 Model Investment Options
ETF Description Objective Benchmark
SPY SPDR S&P 500 ETF Exposure to domestic large-cap companies S&P 500
IJH iShares Core S&P Mid-Cap ETF Exposure to domestic mid-cap companies S&P MidCap 400 Index
IJR iShares Core S&P Small-Cap ETF Exposure to domestic small-cap companies S&P SmallCap 600 Index
EFA iShares MSCI EAFE ETF Exposure to companies in Europe, Australia, Asia and the Far East MSCI EAFE Index
Fixed Income
AGG iShares Core U.S. Aggregate Bond ETF Exposure to the domestic fixed-income market Barclays U.S. Aggregate Bond Index

Your plan should contain at least one fund that closely matches each of the funds listed above. By identifying which funds in your plan correspond to those in the 401 Model (we cover how to do this in our tutorial, or we can do it for you) you’ll be able to implement the 401 Model recommendations inside your specific account.

Interested in using our 401 Model?

The first step is to determine which funds in your specific 401(k) plan line up with the funds in our 401 Model. We’re happy to do this for you, free of charge, all we need is a list of the available funds in your plan. Click the button below to request your free 401(k) matching diagram (select “401(k) Matching Diagram” as reason for contacting).

Request Your Free 401(k) Matching Diagram

Please note that no target date funds are included in this list because target date funds are not a suitable option for 401(k) investors. For more information on why investors should stay clear of target date funds, please click here.

The specific 401 Model performance seen above is based on the following criteria and allocations:

  • The performance of each fund in the 401 Model is analyzed monthly and the portfolio is reviewed and adjusted on the first trading day of each month.
  • The portfolio balance is allocated to the top 3 ranked funds, based on the following allocation percentages:
401 Model Allocations by Rank
Fund Rank: 1 2 3
Allocation 50% 30% 20%
  • If any of the top 3 ranked funds do not meet specific performance criteria, that allocation is placed in the bond fund.

The end result is an innovative strategy that achieves steady growth, while protecting 401(k) investors from major losses associated with market crashes. Regardless of how much you currently have or contribute to your 401(k), the 401 Model can help you achieve better results with fewer scary dips along the way.

The current 401 Model selections and ongoing monthly updates are accessible with a premium subscription. Updated recommendations are provided on the first trading day of each month. Sign up today for access to the 401(k) Allocation Model and all of our other models.

Find Out How to Use the 401 Model to Manage Your 401(k)

The information provided here is for informational purposes only. Model returns do not reflect any management fees, transaction costs or expenses. Investing involves a great deal of risk, including the loss of all or a portion of your investment. Nothing contained herein should be construed as a warranty of investment results. Past performance is not an indication of future results. All risks, losses and costs associated with investing, including total loss of principal, are your responsibility. Model Investing maintains positions in the funds discussed within this site according to model recommendations.
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