It’s indisputable that retirement saving is an essential part of a sound financial plan. But too often, investors mistake the necessity of building a retirement nest egg with the need to keep the money entirely safe. Given the current economic climate, that’s no surprise. We all know how a big hit to a portfolio can impact our sense of wellbeing. But by being too risk-averse, we also risk having too little at retirement to maintain our standard of living.
Unless you’re a seriously late starter (like waiting until age 60 to start saving), a retirement account may be the one place where taking a little risk is most warranted. If structured correctly, your financial plan will be designed to keep your retirement accounts completely separate from your everyday spending needs. In other words, it’s more important to minimize risk in an account containing money you may need to tap your everyday spending. Keep that money in a money market account, CDs and other relatively low-yielding—but liquid—accounts.
With a retirement account, use the benefit of a long-term investing horizon to allocate your money across a range of investments, even those with moderate-to-high risk. The level of risk you choose is dependent on your emotional tolerance for losses, your time to retirement, and the amount you have to save (obviously you want to lean on the more moderate side the less money you have).
To begin with, don’t be afraid of stocks, no matter how brutal the past decade has been. History is no guarantee of future success (as every financial firm likes to say), but a diversified portfolio of stocks has proven to be the best way to capture high returns over the long term. When investing in stocks, remember, diversity it key. If you decide to pick your own stocks, realize that it’s both a lot of work—and potentially costs you a lot of money. When you don’t have millions—or even many thousands—to invest, commissions from amassing a portfolio of 20, 30 or 50 stocks will cost a bundle, eroding your returns.
Related: Understanding the fee structure associated with your 401k.
But investing in stocks doesn’t mean you need to become a stock picker. In fact, most of us shouldn’t be—we don’t have the time, experience, or analytical wherewithal to evaluate a company’s fundamental value. Make it easy on yourself and leave it to the pros. Mutual funds and exchange-traded funds (or ETFs, which are essentially mutual funds that trade like stocks) are easy ways to diversify and gain exposure to a range of investments, from plain vanilla equities to real estate to commodities like gold.
Related: Weigh the Pro’s and Con’s of setting up a self-directed Roth IRA.
After setting up your stock portfolio, then it’s time to layer in things like corporate and government bonds, CDs, and yes, even cash. A good rule of thumb is to increase your allocation in “safer” investments every five years, and then every year as you get within 5-10 years of retirement.
In sum, don’t let the horrors of the recent past scare you from time-tested investing principles, and the opportunities for buy-and-hold investing that a retirement account should provide. It’s certainly smart to continually evaluate the investing world and your own place in it. But fear is never the friend of good investing. As a wise man once told me, “Keep and open mind, but don’t let your brains fall out.”
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The article written above is by Matthew Malone of RothIra.com.