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Rollover Your 401(k) to an IRA in Retirement

Joe Udo

Changing employers or retiring can be a great opportunity to restart your retirement investing with a clean slate. Employer-sponsored retirement plans such as 401(k)s have a lot of restrictions and it is usually difficult to make them work with a particular investment strategy. When you retire, you have the opportunity to rollover the employer-sponsored plan into an IRA. Doing so will give you the freedom to follow any investment strategy you want.

Restrictions. The federal government is the largest employer in the U.S., and we can take a look at their retirement plan to see how flexible it is. The Thrift Savings Plan (TSP) is a federal employee's version of a 401(k) that offers five individual funds for the employee to choose from.

--G Fund - U.S. Treasury security

--F Fund - Fixed Income Index Fund (bond)

--C Fund - S&P 500 Index Fund

--S Fund - Small Cap Stock Index

--I Fund - International Stock Index Fund

They also offer five more lifecycle funds which automatically rebalance the portfolio according to the target retirement age. This is a great start for our federal employees. The big advantage of the TSP is the low fees. The expense ratios are much lower than comparable mutual funds. This is great because you get to keep more of your investment instead of paying the brokerage.

However, there are some problems with having only five funds to choose from. The TSP lacks the ability to diversify through other types of investments. If you want to invest in emerging markets or foreign fixed income, you aren't able to do it in the TSP. The TSP is a great start, but if you want more diversification, you need to invest outside of the TSP.

Rollover. Once you rollover your money to an IRA, you have more choices, which can be good or bad depending on your strategy. If you like simplicity and low fees, then it might be best to stick with the TSP. However, if you want to be in charge of your own investments, rolling over to an IRA will offer a chance to start over with a clean slate. Here are some different strategies that can be executed in an IRA and not in the TSP. It's probably worth talking to a good financial planner to put together a personalized investment plan at this point.

Market cap diversification. One easy way to diversify is to invest in different market capitalization. While the TSP offers large and small-cap, it is missing mid-cap stocks. You can invest in different classifications (value/blend/growth) to further diversify your investment. These classifications should be easy to find from the fund summary or stock profile on Yahoo! Finance. For example, an S&P 500 index fund is a large-cap blend fund.

More diversification. Investors can greatly increase diversification when they control their investments in an IRA. More diversification can help reduce concentration risk and reduce volatility in your portfolio. A good diversification plan should spread your investment out into at least these asset classes: different market capitalization, geological markets, classes of bonds, REIT, energy, gold, and other precious metals.

Equal sector weighted. Another strategy that can further reduce volatility is the equal sectors weighted strategy. The basic idea is the S&P 500 and other index funds are not diverse enough. A S&P 500 index fund has too much exposure to the financial and technology sectors. This is because companies like Apple are very highly valued and make up a large part of the index. By equally weighting different sectors such as utilities, consumer staples, energy, and technology, your portfolio will be more stable.

Market timing and day trading. These are risky strategies that I shy away from. If you are a genius day trader, you might be able to make it work.

Life can be a bit hectic right after you retire, but you need to spare a little time to think about rolling over your retirement portfolio. Once your retirement funds are in an IRA, you can follow your own strategy instead of relying on your old employer's vision. Don't forget to consider other options as well. This is especially true with the TSP where you can opt for a monthly payment or a lifetime annuity. It's not simple, but we need to thoroughly review our options because retirement can last over 30 years these days.

Joe Udo is planning an exit strategy from his corporate job by reducing expenses and increasing passive income. He blogs about his journey to early retirement at Retire by 40.

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