Experts: Never Invest More Than 5% of Your 401(k) in These Funds

A recent Fidelity study found that record numbers of people have become millionaires thanks to their 401(k) investments in 2024. GOBankingRates recently reported that this year introduced 485,000 new millionaires to the world via their 401(k) funds .

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But that doesn’t mean that everyone who follows the traditional advice of investing in a 401(k), especially if your employer matches funds, will achieve this level of wealth. Experts told GOBankingRates that there are some moves you can make with a 401(k) that could be unnecessarily risky. That’s not to say these are bad investments. But they might be either too risky — or too conservative — to help you meet your retirement goals.

Experts like Robert Johnson, PhD, CFA, CAIA, Professor of Finance, Heider College of Business, Creighton University, and co-author of several books, including Investment Banking for Dummies, said that many people decide how to allocate contributions to a 401(k) early in their career and never revisit that plan as they near retirement age.

“Too often individuals are overly conservative with their asset allocations,” he said. “Behavioral research indicates that inertia sets in and people are hesitant to change their initial allocations. This results in a big opportunity loss to people because of time and compounding. Individuals need to be taught to invest for retirement and not to save for retirement.”

He pointed out that large cap stocks, such as those represented in the S&P 500, yielded a 10.1% return between 1926 and 2022, according to data compiled by Ibbotson Associates. While it’s good to maintain a diversified portfolio, to balance growth with risk try not to hold more than 5% of your 401(k) portfolio in any of the following investment classes, experts said.

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Long-Term Government Bonds or Treasury Bills

While common, large-cap stocks were returning more than 10%, long-term government bonds returned just 5.2% annually, Johnson warned. Likewise, U.S. treasury bills returned 3.2% annually, according to Johnson.

While it’s okay to hold a small percentage of your money in these funds to balance riskier investments, Johnson pointed to the old adage, “You can sleep well or eat well.”

He said, “You will sleep well if you commit funds to low-risk investments like money market funds or Treasury Bills, but your investments will not grow substantially and may even have trouble keeping pace with inflation. You will eat well by consistently investing in stocks.”

Especially when you’re young, invest more aggressively to build up that account. You have time to make mistakes and still rebuild your wealth with decades until retirement. “Someone with a long time horizon should not have exposure to money market instruments, yet many investors do because they fear the volatility of the stock market.”

Master Limited Partnership

Some 401(k) plans offer the opportunity to invest in Master Limited Partnerships, which are publicly traded businesses typically focused on real estate or natural resources. MLPs offer tax-deferred distributions and other tax advantages. However, they can be a complex investment that can result in an unwelcome surprise at tax time, said Stephen Kates, CFP, and principal financial analyst for RetireGuide.com.

“MLPs can offer attractive yields that can draw in income-focused investors, but they have unique elements that can make them tricky to own. Unlike most normal stocks, any income over $1,000 generated from an MLP is taxable, even in a retirement account,” he explained.

Company Stocks

Some companies offer employee incentives to buy shares of the company stock in brokerage accounts or 401(k) plans, often providing matching shares. “This can seem like a good idea since you are familiar with the business and obviously believe in it enough to work there,” Kates said. “However, consider that you are already investing in this company through your employment, and adding additional concentration through owning the stock can become too risky….  This is why t’s important to maintain not only a diversified portfolio but one that is diversified outside of your own employment and industry specialization.”

This article originally appeared on GOBankingRates.com : Experts: Never Invest More Than 5% of Your 401(k) in These Funds