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401(k) Allocation Model

401(k) Allocation ModelManaging the investment selections in your 401(k) on an ongoing basis is a requirement if you expect it to be a primary source of retirement funding.

Many investors are lulled into a sense of complacency by their 401(k) plans. They are led to believe that they can simply choose a fund or 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 advantage of growth opportunities while avoiding major losses during severe market downturns.

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

The 401(k) Allocation Model (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 back-tested performance of the 401 Model over the last 17 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 is 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 the financial crisis, while 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 portfolio statistics that allow you to compare the performance of the 401 Model against several benchmarks.

401 Model Portfolio Statistics
Strategy Compound Annual Return Alpha1 Beta1 Standard Deviation Maximum Drawdown Sharpe Ratio Sorentino Ratio Treynor Ratio
401 Model 7.43% 3.93% 0.56 12.85% -13.29% 0.49 1.13 0.11
SPY (S&P 500) 4.41% 0.00% 1.00 18.03% -50.81% 0.24 0.28 0.04
AGG (Bonds) 4.94% N/A -0.05 3.33% -4.30% 0.96 5.44 -0.60
50/50 SPY/AGG 4.68% 1.53% 0.36 5.86% -18.03% 0.52 0.63 0.09
Data for 17-Year Period (2000 – 2016)           1 Benchmarked against the S&P 500

The compound annual return of the 401 Model is significantly higher than that of the other three portfolios. In addition, the 401 Model achieves the best risk-adjusted returns, as measured by the Sharpe, Sorentino, and Treynor ratios. Another measure of risk, maximum drawdown, shows that the greatest peak-to-trough decline was significantly lower for the 401 Model than the portfolio of stocks (SPY) and the 50/50 blend of stocks and bonds.

For a complete description on how to interpret various portfolio statistics, please click here. Or for a quick reference guide, see here.

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 securities are listed below.

401 Model Investment Options
ETF Description Objective Benchmark
Domestic
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
International
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
Stable Value
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
Income
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
Fund Rank: 1 2 3 4 5
Allocation 30% 25% 20% 15% 10%
  • 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.

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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