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Best Ways to Invest a 401(k) Surplus

Brian O'Connell

A recent financial industry report out shows the average 401(k) plan contains $92,000 -- a new high. What's with the extra cash, and what should investors do with the money?

The data comes from Wells Fargo's 2016 retirement study. In it, the financial giant notes that average balance among active participants in Wells Fargo 401(k) plans rose from $56,000 in 2011 to $92,000 in 2016.

That's a hefty upgrade and much of that 401(k) asset growth undoubtedly comes from Americans feeling better about the economy after the Great Recession, and committing to improve their financial futures by steering more cash into retirement plans.

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The question now is, though, what should retirement savers do with that extra cash? Put in aggressive stock growth plans? Pop it into less risk-averse income funds? Go conservative and put the money in bond funds, or even cash?

Be aggressive. Ironically, the same Wells Fargo study states that 401(k) investors are "too conservative" with their plans.

"Almost six in 10 (59 percent) focus more on avoiding loss than maximizing the growth of their investments for retirement," authors say in the report. "Interestingly, this does not vary much across ages: 59 percent of 30-somethings, 62 percent of 40-somethings, 58 percent of 50-somethings and 52 percent of those 60-plus agree with that approach."

The Wells Fargo report offers a clear distinction in aggressive and conservative 401(k) investment strategies. A nest egg of $10,000 on Jan. 1, 1976, would have grown to $581,295 by Sept. 30, 2016, if invested in an allocation of 70 percent stocks and 30 percent bonds.

But if the same money was invested in 70 percent bonds and 30 percent stocks, the $10,000 would have become only $336,715, according to the study.

So, in that time frame at least, aggressive beats conservative by a country mile. Is that the way 401(k) investors should go with their extra cash?

"It really depends on how close to retirement the 401(k) saver is, along with his/her appetitive for risk," says Mike Zaino, president and chief executive officer at TZG Financial, in Charlotte, North Carolina.

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Age matters. An investor between 20 and 40 -- with time still on their side -- would be steered to a riskier portfolio heavily weighted in stocks, Zaino says. But as that person approaches retirement, he'd rely on the propensity for risk.

"If I'm dealing with a gambler, or someone who is otherwise financially stable and could afford to lose 10, 20 or even 50 percent of his portfolio, then stocks are fine," he says. "If, on the other hand, I'm dealing with an extreme conservative or someone who can absolutely not afford to lose and value, then it is index funds, bonds and cash. Until those two variables are determined, it's unwise to point in a specific direction."

Others say that as long as you keep pouring money into your 401(k) -- even extra money -- that should be sufficient, as long as you have a plan in place.

"If someone is able to up their contributions to a 401(k) by several thousand dollars this year, that's great," says Ryan Frailich, a financial planner and founder of Louisiana-based Deliberate Finances. "The most important things when it comes to retirement savings are how much you're saving and when you start, so upping that is huge, especially if you maintain it year over year."

Keep your long-term goal in mind. If you're choosing to save extra into a 401(k), it really shouldn't alter what you're investing that money in, Frailich says. "Whether you're investing $5,000 per year or $10,000 per year, your asset allocation should be designed for your goals, and shouldn't be altered by the amount of money being contributed within the same investment account," he says. "If you had already set up your investments to be split say, 60 percent U.S. stocks, 20 percent emerging markets and 20 percent U.S. bonds, your additional savings would get split exactly the same way since you've already made a decision that your risk/reward desires are aligned to that asset allocation."

The type of retirement fund you're using may alter that strategy, though.

"There may be a difference is in the type of account you are investing," Frailich says. "If you're eligible for a Roth IRA, and you have additional cash to invest, a Roth can be a good way to go to get tax diversification. It's unknown whether tax rates will be up or down from their current levels by the time you retire, so having some money saved in a pre-tax account and some in a post-tax account can help make sure you don't get a big bite taken out."

"If you're purely saving in a traditional 401(K) and tax rates go up to levels we saw in the 1950's, it could have a hugely detrimental effect on your retirement projections," he adds.

There is no shortage of financial professionals who'll advise steering those extra retirement dollars into low-cost equity index funds. But that could leave 401(k) savers vulnerable.

"Index funds have gained tremendous popularity because they do very well when the market is going up," says Andy Yadro, an investment advisor with Googins Advisors in Madison, Wisconsin. "What people tend to forget about is the fact that these funds have no buffer against down markets. Index funds leave you exposed to 100 percent of the volatility and losses during market downturns."

Yadro says that if you're putting extra cash to work, you might want to look into an actively managed fund with a good downside capture ratio.

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"These funds will fare better during periods of market weakness," he says. "Which makes it easier to stay the course during turbulent times."

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