Many investors look at their list of 401k mutual fund choices and put their money in the fund that did the best last year. The only problem with this strategy is that the funds that did well last year are not likely to continue that trend going forward. Past performance is not a guarantee of future results.
Each year, different asset classes outperform, and it’s impossible to predict with consistency which they will be. One year international stocks will do the best and the next year large cap domestic stocks will do better. In 2008 through March of 2009, U.S. Treasuries outperformed all equity markets (and gold). Many investors sold their stock mutual funds as the market declined and piled into bond funds. Shortly thereafter, the stock market surged, recovering much of its losses. But the investors that sold out and went into cash and bonds did not benefit from that run-up.
The best thing to do is to diversify. This is how we manage risk. Allocate a certain percentage to stocks (large and small domestic, international, emerging markets) and some to bonds. Decide what the percentage is going to be, then look at the 401k options to see how to implement it.
Many 401ks have index funds in each of these asset classes. I recommend using them as much as possible.
Another great investment option are asset allocation funds or target date funds. These funds have all of the asset classes noted above within one fund. One of the big benefits of these funds is that the investor doesn’t have to worry about rebalancing. It’s automatically taken care of.