What A Dimmer Switch can Teach you about 401 K Risk
I use this blog as a quick way to introduce you to concepts that will ultimately help you be a prudent investor and steward with money. The topics and posts that I write about are mainly from what I have learned the hard way! I write to you so that you can benefit from my school of hard knocks!
As you know, one of the critical aspects of stewardship is being a good risk manager, not only in investments but rather in all aspects when it comes to money. This is the foundation of success when it comes to money. When we get into the stock market's difficult environments as we are today, it is imperative to be that good risk manager.
One of the principles that I have taught through the years is to monitor your 401 K plans based on the percentage you have invested in stock funds versus bond funds. That is your only choice in most 401 K plans. You have a certain number of stock funds available along with a certain number of bond funds.
Although we can drill down into this concept and get even more technical, it is not necessary to do so for you to evaluate the amount of risk you, yourself, are taking. The concept actually is pretty simple.
"The amount of risk you are taking can be found in the percentage of money invested in stock funds vs bond funds."
This is one of the more basic principles of investing yet, most investors don't put this principle into practice or view risk from this standpoint. If you have 100% of your 401 K plan invested in stocks and 0% in bonds, you are taking 100% of the stock market risk. IF you have 50% of your 401 K plan invested in stock funds and 50% invested in bond funds, you are taking 50% of the market risk. You get the idea. There are all types of combinations, and it is up to you, through prayerful decision making, to select the right combination of stocks and bonds.
Think of it from this standpoint: you install a dimmer switch so that you can control the level of light in a room, you can have it entirely lit or nearly dark by simply pushing the level all the way up or all of the way down. Then, in between, there are many combinations of lighting based on your mood. Think of that dimmer switch as a way to increase or decrease risk. You can increase risk by letting more light in or decrease risk by dimming the level of light you let in the room. Then there are the combinations of light or risk in between. If bonds represent the safe aspect of investing, then why not just be "safe" and invest 100% in bonds?
That is for tomorrow's blog – "What you need to know about Bond Funds!"