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401 Model Tutorial

401(k) Allocation Model

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.

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 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.

Update Frequency

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

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
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

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.

Additional Considerations

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.

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
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.

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 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:

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 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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