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, they are led to believe that they can simply choose a fund (or series of funds), set up a contribution amount, and their retirement will grow on autopilot. All plans encourage workers to update their allocations frequently, but few take the time to do this, and even fewer know how to do it strategically.
Model Investing recommends that you review and adjust your 401(k) allocations on 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.
The 401 Model is designed to keep your retirement funds allocated to the strongest performing areas of the markets, 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 market crashes.
The chart below shows the backtested performance of the 401 Model over the last 19 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 50/50 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.
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 50/50 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 overall 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 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|
|SPY (S&P 500)||4.78%||0.00%||1.00||17.56%||-50.81%||0.26||0.31||0.05|
|Data for 19-Year Period (2000 – 2018) 1 Benchmarked against the S&P 500|
Key Performance Highlights:
- 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 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 and cash.
Every 401(k) plan contains a different mix of available funds. However, if you look deeper, you will see that there is 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 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|
|SPY||SPDR S&P 500 ETF||Exposure to domestic large-cap companies||S&P 500|
|IWR||iShares Russell Mid-Cap ETF||Exposure to domestic mid-cap companies||Russell MidCap Index|
|IWM||iShares Russell 2000 ETF||Exposure to domestic small-cap companies||Russell 2000 Small Cap Index|
|ACWI||iShares MSCI ACWI ETF||Exposure to international developed and emerging market companies||MSCI ACWI (All Country World Index)|
|ACWX||iShares MSCI ACWI ex U.S. ETF||Exposure to international developed and emerging market companies (ex U.S.)||MSCI ACWI ex USA Index|
|EEM||iShares MSCI Emerging Markets ETF||Exposure to large and mid-sized companies in emerging markets||MSCI Emerging Markets Index|
|EFA||iShares MSCI EAFE Index Fund||Exposure to companies in Europe, Australia, Asia, and the Far East||MSCI EAFE Index|
|BIL||SPDR Barclays 1-3 Month T-Bill ETF||Tracks the Barclays 1-3 Month U.S. Treasury Bill Index||Barclays 1-3 Month U.S. T-Bill Index|
|AGG||iShares Barclays Aggregate Bond Fund||Tracks the Barclays U.S. Aggregate Bond Index||Barclays U.S. Aggregate Bond Index|
|BOND||PIMCO Total Return Active ETF||Actively managed bond fund designed to maximize return||Barclays U.S. Aggregate Bond Index|
This comprehensive list should contain a fund that closely matches each of the funds in your specific 401(k). Please note that no target date funds are included in this list because it is the position of Model Investing that 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 historical model performance seen above is based on the following criteria and allocations:
- Fund performance is reviewed and adjusted monthly.
- The portfolio balance is allocated to the top 5 ranked funds, based on the following allocation percentages:
|401 Model Allocations by Rank|
- If any of the top 5 ranked funds do not meet specific performance criteria, that allocation is instead placed in the stable value 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 less overall risk.
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.