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The 401(k) Allocation Model (401 Model) helps you manage your 401(k) plan. It utilizes a dynamic approach to
asset
allocation, allowing you to earn higher returns while taking on less risk.
This tutorial will guide you through applying the 401 Model’s recommendations to your own personal 401(k) account.
The 401(k) Allocation Model is updated monthly. Updated recommendations are accessible with a premium subscription and
are available on the first trading day of each month. They represent proper positioning for the following one-three
months.
Updated recommendations can be accessed through the Current Recommendations
page, available
at the top of our home page once you log in. An email is sent out each month to alert you
when updated recommendations have been posted.
To get the most out of the 401 Model, you will want to update your allocations at least quarterly, immediately upon
receiving the latest recommendations.
n a perfect world, you would update your 401(k) allocations each month based on the latest 401 Model recommendations.
However, as a result of trading frequency restrictions imposed by many 401(k) plan administrators, this could be
considered “excessive trading” and would not be allowed. As a result, we have found that quarterly updates provide a
good compromise between restrictions imposed by plan administrators, and maximizing the benefits of the 401 Model.
For the purposes of calculating historical and future returns, the 401 Model adjusts its holdings each month. However,
based on the factors above, it is advised to allow three months to pass before updating your holdings. This should
ensure that you do not encounter any account restrictions. It may also lead to small differences between your individual
performance and the 401 Model’s hypothetical performance.
Note: If your specific 401(k) plan allows you to update your allocations more frequently (either monthly or every
two-months) without encountering any restrictions, it is recommended that you do so. Updating your allocations more
often will help you stay in tune with changing market conditions.
The 401 Model works by analyzing the performance of each of its funds every month, and allocating the portfolio to the
top three ranked funds.
The first step in updating your account is to determine which funds in your 401(k) plan most closely resemble the funds
in our 401 Model. The easiest way to do this is to compare the Objectives and Benchmarks of the funds in our 401 Model
with those of the funds in your plan.
For example, utilizing the chart below, if you wanted to find a corresponding fund in your plan for IJR – iShares Core
S&P Small-Cap ETF, then you would search your 401(k) plan options for a fund that has exposure to small-cap companies
and/or is benchmarked to the S&P SmallCap 600 Index. Once you’ve done this for all five funds in the 401 Model, you’ll
be ready to implement the model’s recommendations directly inside your account.
(Please Note: We know this can be confusing and are more than happy to do this for you free of charge. If you’d like
our
assistance in creating a matching diagram for your specific account, please Contact Us.)
| 401 Model Investment Options | |||
|---|---|---|---|
| ETF | Description | Objective | Benchmark |
| Domestic | |||
| 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 |
| International | |||
| 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 |
If you decide to do this on your own, keep in mind that many 401(k) plans have begun to include index fund options in
addition their “managed fund” counterparts. An index fund is a passively managed fund that automatically (without human
intervention) tracks a particular benchmark. This approach differs from a managed fund, where a fund manager is actively
picking stocks to try and beat the benchmark.
Data across many decades shows that actively
managed funds
are unable to outperform the market in aggregate, yet they charge significant fees to pay the management
team. If you have the option, you always want to choose the index funds in your plan rather than their actively
managed counterparts. Statistical
data suggests
you will be much better off in the long run for doing so.
Once you’ve identified the five funds in your 401(k) plan that correspond to the funds in the 401 Model, you then
need to adjust your allocations according to the table below.
| 401 Model Allocations by Rank | |||
|---|---|---|---|
| Fund Rank: | 1 | 2 | 3 |
| Allocation | 50% | 30% | 20% |
Within your 401(k), you have the ability change the allocations of your current investments, and you also have the
ability to change the allocations of future contributions. The 401 Model’s outperformance of stock and bond benchmarks
is achieved by reallocating current investments to the top ranked funds on an ongoing basis. This means that you must
adjust your current holdings based upon the 401 Model’s recommendations, not simply the allocation of future
contributions.
Once your allocations have been updated, you are set for the next one-three months.
The historical backtested performance of the 401 Model is based on following the model exactly, moving the entire
portfolio according to each month’s recommendations. While the results speak for themselves, we understand that you may
be hesitant to fully embrace an investment strategy that you’re not familiar with.
If that’s the case, we suggest using only a portion of your account to follow the 401 Model’s recommendations. As you
see the results over time and become more comfortable with the model’s performance, then consider applying this strategy
to a greater percentage of your account.
For more sophisticated investors, you may also consider modifying the recommended allocation percentages to better suit
your specific goals and risk tolerances. Allocations can be tailored to whatever you are comfortable with, as long as
you follow some basic guidelines.
The primary consideration to keep in mind if you choose to modify the suggested allocations is to have the highest
allocations in the top ranked funds, and lowest allocations in the lowest ranked funds. In the table below we have
included some hypothetical allocations, followed by an explanation of the benefits and drawbacks of each.
| 401 Model Example Allocations | |||
|---|---|---|---|
| Fund Rank: | 1 | 2 | 3 |
| Example Allocation 1 | 34% | 33% | 33% |
| Example Allocation 2 | 60% | 30% | 10% |
| Example Allocation 3 | 20% | 30% | 50% |
Allocation 1 evenly distributes your account balance across the top 3 ranked funds. By not investing
more
in the higher
ranked funds and less in the lower ranked funds, you would miss out on some of the benefits of relative strength and
momentum. Your portfolio may be less susceptible to losses as a result of greater diversification, but its growth
potential may also be slightly reduced.
Allocation 2 strongly over-weights the top ranked fund. This can enhance performance, but also
increases
overall risk as
the portfolio is less diversified. It can be an effective strategy for increasing returns, just be aware that it can add
volatility to your portfolio and potentially result in greater losses during periods of market turmoil.
Allocation 3 misses the concept of allocating a higher percentage to the top performing sectors. This
type
of allocation
should be avoided.
To reiterate, the allocations used in the 401(k) Allocation Model provide a good starting point and are what the
historical backtested results are based upon. If you choose to modify your allocations, your performance will differ
from the 401 Model’s historical and future results.
On the Current
Recommendations
page you will find the latest 401 Model recommendations and you will also find a table that ranks all the funds
in the 401 Model from best to worst. We have included this information for those who may wish to deviate slightly
from the model’s recommendation, either for diversification purposes or other reasons. In the Complete Ranking
Table, you will notice a color coding schema designed to alert you to the status of each option. The color coding is
as follows:
| Key | |
|---|---|
| Green | Showing positive price performance and acceptable as an investment |
| Yellow | Acceptable as an investment but significantly better alternatives exist |
| Red | Not recommended at this time |
All items in green are considered acceptable investments, but we recommend you stick with the highest ranked options to
achieve optimal performance.
As a final reminder, not following the 401 Model’s exact strategy and recommendations will result in returns that differ
from the model’s historical and future performance.
This wraps up the 401k Tutorial.
If you have additional questions please reach out to us.
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.
