If you’re young and will be making regular and continuous contributions to your 401(k) plan over a number of years, history shows that allocating all of your deferral into stocks will likely produce the highest returns.

[Ed. Note: That’s pretty much the main point of Step 2. You can go on to read a bad joke or two and a couple of graphs that show how many hundreds of thousands of dollars might be at stake by putting your money into the right or the wrong allocation over time. Boring stuff like that — so feel free to head on over to Cheeze-O-Rama if you know all this stuff already. Or you can skip to Step 3. which is a good bit, and features a guest appearance by Alex Trebek.]

For anyone new to handling her own finances, the array of investment choices provided by a typical 401(k) plan can be dizzying. Unfamiliar names jump out from the asset allocation sign-up sheet, including such obviously frightening concepts as guaranteed investment contracts (GICs) and the all-too-familiar sounding bank deposit accounts. Sometimes there will be 20 or more individual choices offered, and usually employers offer little help in navigating what allocation might be the right one for you.

The chart at the end of Step 1 shows the results that can be achieved if you invest that deferred pay and achieve returns, before tax, of 8% a year on your investments. To do better than that, or at least improve your chances of doing better than that — it helps to understand the historical performance of the usual choices.

The typical investment choices in a 401(k) plan are likely to be:

• Money market funds

Kidding. Llamas are not offered as an investment vehicle under any 401(k) plans. If your 401(k) is for some reason offering llamas, consider instead working for a company that is not run by somebody who’s insane. Choosing to invest in llamas cannot possibly help your retirement. Now, back to the boring stuff…

Money-market funds and stable value accounts offer secure ways to make sure that your savings grow at a limited rate. You won’t make much off any money put into these vehicles, but you don’t stand much chance of losing any either as they consist mainly of certificates of deposit or U.S. Treasury securities.

Bond mutual funds are pooled amounts of money invested in bonds. Bonds are IOUs, or debt, issued by companies or by governments. A purchaser of a bond is lending money to the issuer, and will usually collect some regular interest payments until the money is returned. Usually, the amount of interest paid —the coupon — is fixed at a set percentage of the amount invested, thus, bonds are called fixed-income investments.

Stock or equity mutual funds are pooled amounts of money that are invested in stocks. Stocks represent part ownership, or equity, in corporations, and the goal of stock ownership is to see the value of the companies increase over time.

Let’s take a look at another graph, this one comparing the average historical returns of money market funds, bond funds, stable value accounts, and stock funds.

Looking at this graph, you’d wonder why anybody would ever decide to put any of her money into anything but stocks. Yet according to data compiled recently by the Department of Labor, less than half of all 401(k) plan assets are invested in equities.

Why is that?

Mostly because people haven’t been fully informed about the historical returns of stocks versus the other choices. Also, stocks are perceived by many to be too risky, and for those who are getting closer to retirement age, it certainly does make sense not to be completely invested in stocks. Over the short term (five years or less), stocks can offer a very bumpy ride.

There are any number of asset allocation models that propose putting as much as 20% of your money into cash or money market funds, and 25% or more into bond mutual funds. Those who are young and are putting money away for two decades or more should ask themselves whether the decreased volatility of such a model is worth the guarantee that it will not match the historical 11% average annual returns of equities.

If you have a 401(k) plan administrator, she won’t tell you how to invest your money, even if she knows that, historically speaking, stocks outperform other types of investments. Generally, plan administrators won’t expose themselves to any legal liability and won’t offer specific investment advice — markets, after all, don’t end up behaving in predictable ways all the time. Or any of the time.

We can’t offer specific investment advice to you either, because we don’t know your specific situation. (Our message boards, however, are an excellent place for you to discuss your specific situation with the Foolish community at large. Register for free by clicking here .) But if there’s a sufficient reason for someone who is decades away from retirement not to take full advantage of the fantastic possibilities that stocks provide, we don’t know what it is.

All you’ve got to do to maximize your returns, therefore, is pick the right equity mutual fund. There’s a good chance that your 401(k) has the right fund for you.

But did you know that only 15% of all the 401(k) funds that are put into equity mutual funds are put into the best performing funds? Do you want to know how you can beat 85% of your co-workers? Read on.

See Also