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401(K) asset allocation

When you’re enrolling in your employer’s 401(K) plan, one of the most difficult questions is your 401(K) asset allocation. They’re limited in what advice they can give you, so I’ll share what’s worked for me.

The key to 401(K) asset allocation is to get a good mix of stocks of large companies, medium-sized companies, growth stocks, international stocks, and bonds. This helps you to do well over the long term, even when the market has bad years.

First, a disclaimer

401k asset allocation

401(K) asset allocation can be tricky to get right, but with these recommendations and a calculator, you can do well.

I am not a financial advisor, and I make no guarantees and can assume no liability regarding these recommendations. This is what worked for a former coworker, who shared it with me, and it worked well for me as well. I can tell you I’ve followed this asset allocation as closely as I can since 2009, and my results have been outstanding.

All that said, this strategy is similar to what many of the target-type options your 401(K) offers will use. If you want a bit more control than what those options give you, or need to replicate that strategy in  rollover account that doesn’t offer that kind of option, this formula tells you how to do it.

My dad used to spend hours and hours reading financial information and watching shows like Louis Rukeyser’s Wall Street Week. This formula is designed to give results almost as good, with a lot less work. Not to mention less chance of mistake.

Why 401(K) asset allocation matters

It’s important to spread out your investments in order to spread out risk. As tempting as it is to ride a hot hand, eventually that strategy fails. You would have done really well investing solely in Apple or Amazon in the 2010s, but that doesn’t necessarily last forever. In the 90s, the hot stock was Microsoft. In the 80s, it looked like IBM could do no wrong, and today people wonder whether IBM even still exists.

Your employer’s 401(K) probably doesn’t even give you a way to invest all of your earnings in a single stock. Instead, you get to choose a mix of mutual funds. Mutual funds are pools of stocks and bonds. By buying into the pool, you invest in a variety of companies, without having to pick and choose them yourself.

With a shrewd asset mix, some years it’s possible to make money even though the market as a whole went down. But even when you have a down year, stocks will make it back in subsequent years. That’s why you shouldn’t be afraid of stocks.

Now, asset allocation isn’t the only question you’ll have to deal with. If you have the choice of using a Roth 401(K), here’s an explanation of the trade-offs between a Roth 401(K) and conventional 401(K).

401(K) target year funds

If your 401(K) is like mine, it offers a bunch of investment options with names like Target 2040 and Target 2045. These are funds that are designed to balance return on investment and safety, based on your expected retirement year. You just pick the fund that most closely matches the year you’ll reach retirement age, and the fund manager handles the rest, investing aggressively when you’re young and growing more risk-averse over time, since you’re more likely to need the money in the short term the closer you are to retirement.

For someone who doesn’t understand investment all that well and doesn’t really have any interest in learning, these are good options. Maybe great options, even. Contribute at least enough to max out your employer match and do that as long as you can, and you’ll do rather well.

This works for several reasons. First, since you’re receiving an employer match, you get an automatic return on investment thanks to that employer subsidy.

But the real magic happens in the balancing. When the market goes up and down, it’s rare for every type of investment to go in the same direction. If the fund sets out to keep 30% of its holdings in large companies, and the value of large companies increases, your fund sells some of those assets and buys something that went down to maintain the balance. This forces an automatic buy-low sell-high strategy.

This, along with investing every payday to ensue dollar cost averaging, helps protect you and can even make you profit from market volatility.

DIY 401(K) asset allocation

If you want a bit more control, or you’ve rolled 401(K)s from previous employers into a rollover plan because they were charging you fees to manage them and you lost the automatic option, here’s the logic that goes into those funds so you can replicate or fine-tune them based on your own risk tolerance.

While this is a more hands-on approach than simply choosing a target year fund, this is a long way from what a financial advisor considers hands-on management.

For optimal results, you want to invest in about five classes of investments: large domestic stocks, mid-cap domestic stocks, international stocks, growth stocks, and bonds. You can achieve this by holding as few as four mutual funds, depending on what options are available to you. Yes, you can get five classes in four funds.

The overall mix

The overall mix to use works something like this:

  • 30% large cap domestic stocks
  • 20% small cap domestic stocks
  • 20% international stocks
  • 20% growth stocks
  • 10% bonds

This is an aggressive mix. To tune it, you increase your holdings in bonds and decrease your holdings in the other types. This kind of allocation is fine when you’re in your 20s and 30s. You can scroll through my recommendations for your 40s, 50s, 60s, and 70s to get to my recommendations for fund choices for each type.

401(K) asset allocation by age

Now, let’s go over 401(K) asset allocation by age. All we have to do is adjust the mix to make it less aggressive over time, by increasing the bond holdings while holding the relative percentages of what’s left fairly constant. Arguably you could reduce stock holdings just to large-cap stocks, but that leaves more exposure when large-cap stocks have a bad year. I think maintaining some diversity in stocks actually decreases your risk.

The key is adjusting the balance to decrease how much a bad year can hurt you. In your 20s and 30s, you have plenty of time to make up for a bad year. In your 60s and 70s, that’s no longer the case.

A mix for your 40s

In your 40s, consider adjusting your asset allocation to something like this:

  • 26% large cap domestic stocks
  • 18% small cap domestic stocks
  • 18% international stocks
  • 18% growth stocks
  • 20% bonds

A mix for your 50s

Here’s an asset allocation mix for your 50s. Note that if you can split small cap, international and growth stocks evenly, it’s perfectly OK to do so. I had to round one up and the others down to get an even 100%.

  • 20% large cap domestic stocks
  • 14% small cap domestic stocks
  • 13% international stocks
  • 13% growth stocks
  • 40% bonds

A mix for your 60s

For your 60s, your asset allocation again increases its bond holdings. If you can hold equal amounts of small cap, international and growth, that’s OK. I had to round one down and the other two up to hit 100% evenly.

  • 14% large cap domestic stocks
  • 9% small cap domestic stocks
  • 9% international stocks
  • 8% growth stocks
  • 60% bonds

A mix for your 70s

By the time you reach your 70s, your asset allocation needs to be very conservative because you’re probably in retirement and drawing out some of that money. Since you won’t be using it all at once you want some stock holdings so your holdings can grow and outpace inflation, but the safety of bonds is your friend at this point.

  • 10% large cap domestic stocks
  • 7% small cap domestic stocks
  • 7% international stocks
  • 6% growth stocks
  • 70% bonds

Finding the right types of holdings for your 401(K) allocation

Your 401(K) plan probably won’t have choices by these specific names. What I can give you are some key words to look for. Every plan that lets you pick individual holdings will have at least one mutual fund in each of these categories. They may have a few more too, but you’ll probably want to ignore those.

Large cap domestic stocks

These are huge companies like Apple, Amazon, and yes, even old names from the past like Microsoft and IBM and General Electric and Ford Motor Company. There’s some growth left in the rising stars in this category, but the main appeal with these companies, especially the stodgy old ones, is that they pay dividends. The value of the stock may not go up much, but they’re sending your fund manager checks every quarter, injecting more money into the mix.

If your fund offers the choice to invest in the Wilshire 5000, you can knock out the first two investment classes in one choice. This fund invests in the 5,000 publicly traded companies in the U.S. stock market. Just add the two percentages together and buy the Wilshire 5000.

If you don’t have the option of the Wilshire 5000, choose the S&P 500 to invest in.

Small cap domestic stocks

These are the 4,500 publicly traded companies that aren’t big enough to be in the S&P 500. These companies tend to be a bit more nimble, so they can have a good year when the big companies are taking a beating.

Most 401(K) plans offer a fund called the Wilshire 4500 to catch these smaller companies. If you can’t find that specific phrase, look for a fund with the number 4500 in its title. That’ll be the one you want.

International stocks

International markets can be more volatile than the U.S. stock market, but they also don’t necessarily follow the same ebb and flow as U.S. stocks do. If you’re rebalancing your mix on a quarterly basis, this volatility provides a money-making opportunity.

Most 401(K) plans will offer some sort of international fund. The name will vary, but look for a fund with “international” in its name.

Growth stocks

Growth stocks can be the most volatile of all, but when they have a good year, they have a very good year. This asset class will give you heartburn when it’s having a bad year, but its good years will make up for it.

Most 401(K) plans offer some sort of growth or opportunity fund. A specific fund that I’ve used in the past that you might look for is American Century Ultra.


Bonds offer the lowest volatility of everything I mention here, so people generally regard them as the least risky. The problem is the returns are also very low.

There are many classes of bonds but your 401(K) plan probably will only offer one or two. If they offer a choice between U.S. government bonds and international bonds, you’ll have to make a judgment call. Common choices include splitting 60/40, but 50/50 is almost as good and easier to calculate. Traditionally, U.S. government bonds have been the safest choice, but there’s some question whether that will hold in the future.

Automatic rebalancing

If you take a DIY approach, make sure your 401(K) plan has an option for automatic rebalancing to keep your 401(K) asset allocation right. Otherwise, the ebbs and flows of the market will throw your balance off over time, and the way you make money off market volatility is through buying and selling. Rebalancing once a quarter is sufficient.

If your plan doesn’t offer automatic rebalancing, you’ll have to do the math and rebalance by hand. Most plans don’t allow you to buy and sell the same fund within 30 days, so if you rebalance by hand, do it no more than once a month. Theoretically you may be able to do a little better rebalancing more frequently than once a quarter, but don’t run afoul of the plan’s rules.

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