Roadmap to Riches  
how to invest your 401(k)
Investments: Choosing the right investment mix
How Do We Use Knowledge Of Style and Cycles To Craft An Investment Strategy?
By mixing a combination of investment styles, we can reduce our risk and achieve more consistent long-term results. Once we have determined that funds investing in the stock market are appropriate as a part of our 401(k) investment mix, we need to choose a combination of different investment styles. With just two mutual funds having the same style, our results would look like this:
With two mutual funds having different styles, our results will look more like this:
The line up the middle is the (Path of Minimum Regret) - a composite result of two inversely co-related investment types.
EXAMPLE
In the real world, performance comparisons do not reveal themselves as perfect figure eights. But the following graph representing the actual performance of three mutual fund types shows how fund performance varies dramatically from year to year. The fund types illustrated below are as follows:
- S&P 500 Index
- Small Company Index Fund
- Foreign Stock Index Fund
The chart also illustrates the average return of all 3 fund types which we call “The Path of Minimum Regret.” To say the least, it is not a straight line, but it represents a straighter line than any single fund type on the chart.
THE POINT: Every dog will have its day in the investment business. It is impossible to predict what style will be the next winner with any certainty. Therefore, you reduce risk by diversifying across a variety of styles. This concept is called Modern Portfolio Theory. It is a technique that reduces risk without necessarily reducing returns.
What is the Biggest Risk Facing a 401(k) Investor?
The biggest investment risk for 401(k) investors is The RISK OF ABANDONING A STRATEGY. Once an investor has carefully determined the time required for their 401(k) goals and has chosen an investment mix for those goals, the most important factor generating future success is to not deviate from that strategy. People who “freaked out” in October of 1987 and moved into money market funds after a two day 25% drop in values missed out on the opportunity to be even again within six months. They missed what could have been a tripling of their assets since that time. Investors who moved into cash in the seventies missed out on what would have been a ten-times increase in values had they stayed in the market.
The Bottom Line
Choosing an investment mix is a methodical process requiring a careful assessment of your future needs and an appreciation of what different types of investments have historically accomplished. Too many investors struggle to chase last year’s best performing mutual fund or try to “time the market.” Relax. Spread your assets thoughtfully. Let the market and your confidence do the work, and you can be a winner.
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