With the right investment choices and diligent contributions in a retirement portfolio, investors stand a good chance of achieving their financial goals — maybe even more. The wrong investment mix, however, can get investors close to nowhere.
Retirement Tip of the Week: Look carefully at what you’re invested in, and understand what it means for your portfolio, future returns and retirement goals.
A portfolio’s asset allocation, which is the breakdown of its investments, can make or break a retirement plan. Invest too heavily in stocks right before you retire with no backup money to draw from, and your assets can take a hit if the market tumbles as you enter retirement. Invest too conservatively for the decades leading up to retirement, and you might not have enough to live on in old age.
There’s no one right answer when it comes to how to invest your retirement savings, but it’s important to approach these decisions carefully. There are asset allocation calculators available on personal finance sites, including SmartAsset and Bankrate, as well as financial institutions’ websites, such as Fidelity, that can help novice investors understand how they should strategize. Of course, these calculators do not replace the advice of a qualified financial planner who can walk through all your goals, financial statements and emotional approaches to money.
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First, a quick introduction to investing. The three most common asset classes include stocks (known as equities), bonds (considered “fixed income”) and cash or cash equivalents (such as the money in your checking accounts or CDs). There are alternative classes as well, including real estate, commodities and nowadays, cryptocurrencies.
Within these classes are different types of investments, too. For example, under equities, investors can find large-cap equities, which are invested in some of the bigger corporations in the country (like Amazon
); small-cap, which invest in smaller companies; and international funds, where investments are in companies outside of the U.S.
Under fixed income, investors could find government-backed bonds, mortgage-backed securities or securities that corporations issue.
Keep in mind: this is a basic synopsis of investing, and the types and ways to invest within these asset classes can feel limitless. Investors are encouraged to diversify among asset classes, such as having a mix of stocks, bonds and alternatives, as well as diversify within these classes, such as different types of equities.
Schwab broke down an example of asset allocations for different types of investment approaches. A conservative allocation may only have 15% invested in large-cap equities, 0% in small-cap equities, 5% in international equities, 50% in fixed income and 30% in cash. Comparatively, an aggressive allocation could be 50% in large-cap equities, 20% in small-cap funds, 25% in international stocks, 0% in fixed income and 5% in cash.
Deciding on the right allocation comes down to various factors, including the time until the investor needs the money, that person’s age and his risk tolerance, which is how comfortable he is with investments and volatility. Beginner investors may also consider target-date funds, which are investments tagged to an estimated year of retirement, and automatically adjust the asset allocation to be more conservative the closer it gets to that date. These investments are not personalized, but it’s a first step. “At least it gets you started, and it takes out a lot of the anxiety and stress,” said Erin Lowry, personal finance writer and author of “Broke Millennial Takes on Investing.”
A quick note about risk tolerance — sometimes, investors may want to consider more aggressive investments than they’re usually comfortable with, such as if they have decades until retirement. Younger investors can withstand to invest more aggressively, as they have decades until that money needs to be withdrawn. Financial advisers can talk to investors about risk tolerance, which is how comfortable the individual is with investments, versus risk capacity, which is how much risk the individual can take on to meet financial goals.
Still, not everyone is ready to jump into an equity-heavy portfolio, in which case Lowry suggests starting with a more conservative approach. “You can always change it to be more moderate or more aggressive,” she said.
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