I just started a new job and part of the orientation process involved setting up my retirement plan. Once I determined which retirement account was best for me and how much I wanted to contribute each month, I then had to choose how to invest the money in that account. When it comes to investing money for retirement, here are 3 general rules I follow:
1. Make sure it’s profitable. Retirement plans don’t just help us save money on taxes and stash cash for a later date. One of the biggest perks of retirement accounts, is the opportunity to invest the money and make a profit. When you contribute towards your 401K, 403b, or IRA, the money is simply sitting in an account. In order to make a profit on that money, you must actually invest that money. Most employer-sponsored retirement plans (401K, 403b, 457) give you the option to choose different “index funds” that invest in stocks, bonds, or a combination of the two. Bonds are a “safe” investment but the returns on your money (aka profits) are quite low and barely keep up with yearly inflation. In order to make your contributions profitable and increase the value of your retirement portfolio, you should invest in some percentage of stocks.
2. Make sure it’s diverse. When it comes to investing in stocks, I do not mean buying individual shares of Amazon or Netflix. Buying individual stocks carries enormous risk. Even a big company like Walmart can experience less profitable periods where their revenues don’t meet expectations, decreasing the price of their stock and the value of your investment. As lay persons with jobs, it can be difficult to predict which companies or industries will be the most profitable 5-10 years from now. Even if we stay informed on company news, there is no way we could outsmart the people on Wall Street who have the latest information right at their fingertips (and even those experts get it wrong 50% of the time!) The key to managing this risk, is to invest in many different companies in a variety of industries. Since we don’t have an endless amount of money, the most effective way to do this is to invest in index mutual funds. The total stock market index fund, for example, buys almost all of the public stocks in the country. That way if one industry experiences a downturn, your stock investments in all of the other industries will prevent you from losing too much money. Plus, being this diversified may allow you to make an even larger profit when small startups companies experience unexpected growth or turn into the next Facebook.
3. Make sure it’s safe. While we want our investments to be profitable, we must also ensure they are not too risky. People who had all of their retirement savings invested in stocks during the crash of 2008 lost a lot more money than those who had invested some of their money in bonds. A general rule of thumb is that your stock-to-bond allocation should be 100 minus your age. If you are 25 years old, you should have 75% of your money in stocks and 25% in bonds. If you are 45, you should 55% in stocks and 45% in bonds. Since people are living longer nowadays, some experts suggest using 110 or 120 minus your age instead. Regardless of which estimator you use, your ideal allocation of stocks to bonds, should be based on your comfort level. Take a look at the investment fund options available through your job or through various companies like Fidelity or Vanguard and pick a stock-to-bond portfolio allocation in which you are most comfortable.
WHAT AM I DOING? As a 28-year-old female who is new resident physician, I’m investing in Vanguard’s Target Retirement 2050 fund. This index mutual fund is a type of lifestyle investment fund that automatically adjusts the percentage of stocks and bonds as I age. Money in this fund is actually invested in 4 other index funds:
-53.5% in the “total stock market index” fund (which purchases stocks from nearly every public company in the US)
-36% in the “total international stock market index” fund (which purchases over 5,000 stocks from over 40 different countries around the world)
-7.5% in the “total bond market index” fund (which purchases a mix of over 8,000 corporate and government bonds offered in the US)
-3% in the “international bond market index” fund (which purchases thousands of bonds from developed countries and emerging markets around the world)
As you can see from the breakdown, the allocation starts off with about 90% in stocks and 10% bonds, since I’m young and plan to work in some capacity for another 30 years. However, it periodically decreases the percentage of stocks and increases the percentage of bonds as I age. This advantage of this changing allocation is that I have more risk and thus a bigger chance of higher profits when I’m young (since the majority of this fund is in stocks), but become less risky as I age (since the percentage of bonds will increase overtime). Another advantage of this fund is that it decreases the work on my behalf. Instead of investing in these 4 funds individually, investing in this Target Retirement lifestyle investment fund allows me to purchase this 1 fund, which then automatically has me invested in the 4 other funds.
As I get older and more experienced, I might choose to invest in different index mutual funds or open a Roth IRA to invest in other things like real estate, but as a busy resident who is just getting started with retirement investing, this is my fund of choice. Whether you choose to adopt my game-plan or come up with one of your own, remember the 3 rules to retirement investing: Keep it profitable, keep it diverse, keep it safe.
Tell me, are you saving money for retirement? If so, how do you plan to invest the money in your retirement account?