You Rolled a Large 401(k) Into an IRA. Now How Should You Invest It?

You spent 20 or 30 years building your 401(k). Maybe it is now worth $500,000, $750,000 or more than $1 million. You leave your employer or retire, roll the money into an IRA, and suddenly the money is sitting there.

Now what?

For many people, this is the first time they have really had to answer that question.

While working, investing was relatively simple. Your employer selected the investment choices available in your 401(k). You may have picked a target-date fund, an S&P 500 index fund or a conventional mix of stock and bond funds. Then you contributed from every paycheck and let the account grow.

After rolling the money into an IRA, you suddenly have considerably more investment choices. That flexibility can be valuable, but it also creates a new responsibility: deciding how the money should actually be invested.

I think the mistake is starting with, “What should I buy?”

A better place to start is: “What does this money need to accomplish?”

Someone retiring next year and relying on the IRA for living expenses is in a very different position from someone who is 55, still working and doesn't expect to touch the money for another 10 or 15 years.

The IRA doesn't necessarily need one investment objective either.

For a retiree, part of the account might be invested more conservatively to provide stability and future withdrawals, while another portion with a longer time horizon might be invested for growth. Someone with substantial assets elsewhere may have even greater capacity to use part of the IRA for higher-growth investments.

This is why simply recreating your old 401(k) may not always be the right answer. Your circumstances may have changed, and an IRA generally gives you access to investment choices that weren't available inside your employer's retirement plan.

There is another mistake I occasionally see after a rollover: doing nothing.

The rollover arrives in the IRA and remains in cash or a money-market fund while the investor decides what to do. There is nothing wrong with temporarily parking money somewhere safe while making an investment decision. The problem is when temporary becomes six months or a year without the investor ever intentionally deciding that cash is where the money belongs.

This happens partly because many successful people have accumulated substantial retirement savings without ever becoming investment experts. Investing isn't something most of us were taught in school. Someone can have a successful 30-year career, diligently contribute to a 401(k), and retire with $1 million without ever having needed to construct an investment portfolio themselves.

A large rollover IRA deserves more thought than simply picking a few funds.

Consider when you will need the money. Think about how much income you will need from it, what other assets and income you have, how much volatility you can tolerate, and how much of the account truly has a long-term investment horizon.

Only then should you decide how much belongs in conservative investments, traditional long-term investments or potentially higher-growth strategies.

Building a large 401(k) may have taken decades. Deciding what to do with it after a rollover deserves some thought too.

Before asking, “What should I buy?”

Start with a different question:

“What does this money need to do for me now?”