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401 Model Tutorial

401(k) Allocation ModelThe 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.


Getting Started

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 login. An email is sent out each month to alert you that updated recommendations have been posted.

To get the most out of the 401 Model, you will want to update your allocations quarterly, immediately upon receiving the latest recommendations.


Background

In 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.


How to Use

Each month the 401 Model will identify the top 5 ranked funds from the list below.

The first step in updating your account is to find the specific funds in your 401(k) plan that most closely resemble the top five 401 Model selections. Based on feedback from clients, we have found that the easiest way to do this is to compare the Objectives and Benchmarks of the 401 Model selections to those of your 401(k) plan investment options.

For example: Utilizing the chart below, if the top performing fund is the IWM – iShares Russell 2000 ETF, then you would search your 401(k) options for a fund that has exposure to small-cap companies and/or is benchmarked to the Russell 2000 Index. Do this for all five of the top performing funds.

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

Note: Recently, and thankfully, some 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 invest in index funds rather than their actively managed fund 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 each of the top five 401 Model selections, you then need to adjust your allocations according to the table below.

401 Model Allocations by Rank
Fund Rank: 1 2 3 4 5
Allocation 30% 25% 20% 15% 10%

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 equity 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 three months.


Additional Considerations

The historical back-tested 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 if you are hesitant to fully embrace an investment strategy that you are not familiar with.

If this is 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.


Advanced Users

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 4 5
Example Allocation 1 20% 20% 20% 20% 20%
Example Allocation 2 60% 25% 10% 5% 0%
Example Allocation 3 10% 15% 20% 25% 30%

Allocation 1 evenly distributes your account balance across the top 5 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 back-tested results are based upon. If you choose to modify your allocations, your performance will differ from the 401 Model’s historical and future results.


Color Coding

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 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.

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 401 Model Tutorial.

If you have any additional questions, please reach out to us by using the Contact Us page or sending an email to support@modelinvesting.com.

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