Traditional Investments Used for Retirement Investing
Saving for retirement is similar to saving for other things in that you have similar investment options. Here is a run-down of the traditional investments and how they can work as retirement investments.
Stocks
Stocks provide the highest potential growth of all retirement investments but also come with the highest potential risk. A higher allocation of stocks is best early in your career when there is plenty of time before retirement to deal with any downturns in the market.
Bonds
As a retirement investment, bonds provide a lower growth rate than stocks but are much less risky in an economic downturn. It is a good idea when saving for retirement, to increase your allocation into bonds while decrease retirement investment allocation of stocks.
Saving for retirement is similar to saving for other things in that you have similar investment options. Here is a run-down of the traditional investments and how they can work as retirement investments.
Stocks
Stocks provide the highest potential growth of all retirement investments but also come with the highest potential risk. A higher allocation of stocks is best early in your career when there is plenty of time before retirement to deal with any downturns in the market.
Bonds
As a retirement investment, bonds provide a lower growth rate than stocks but are much less risky in an economic downturn. It is a good idea when saving for retirement, to increase your allocation into bonds while decrease retirement investment allocation of stocks.
Mutual Funds
Mutual funds encompass a wide range of different types of funds available. This can include anything from an actively managed fund to an indexed fund. Actively managed funds will typically invest in a mixture of both bonds and stocks in an attempt to beat the market. Index funds are cheaper because they are not actively managed and attempt to hold stocks or bonds as a mirror of the market and tend to perform close to the performance of the market.
As a retirement investment, mutual funds can be a good way to diversity your portfolio without the micromanagement that may be involved. Mutual fund allocation decisions should be made based on what types of stocks or bonds they invest in along with what type of asset allocation there is within the mutual fund itself.
Retirement Investing with Retirement Accounts
When saving for retirement, you have a few tools that are not available for other type of investments. These retirement accounts are built specifically to support your retirement investing. Here is a quick rundown of the different types of retirement investment accounts available.
401k
The 401k is an employer sponsored retirement investing account. Like all three of these investments, it is tax-deferred meaning that you are not taxed on the funds you place into these accounts until you withdraw them. 401k is the most popular retirement investment account and should be exhausted first because of the potential for employer deposit matches or contributions. There is a limit of $16,500 a year that can be put into your 401k.
IRA
An Individual Retirement Account (IRA) is similar to a 401k with the tax deferral feature. It only has a $5,000 yearly contribution limit and there is no chance for employer contributions. Once your 401k has been fully contributed to, you should put remaining money into your IRA until the limit is reached.
Annuities
Retirement Annuities are offered by life insurance companies and have very high fees of around 3% a year. These instruments should only be used for retirement investing if the specific features offered are worth the 3% fee. These retirement investments are rather heavily pushed by financial salespeople because of the very high commissions they provide. Make sure you are informed before diving headlong into something that could very well be a poor retirement investment choice for you.
To read more about these different retirement investments, see our article on Retirement Accounts.
Asset Allocation Strategies
Asset allocation for your retirement investing should depend primarily on age and distance from retirement. It is always a good idea to have a mixture of different retirement investments rather than focusing exclusively on one so you can diversify your portfolio and control for risk more effectively.
There are three phases of your life you should focus on when allocating your retirement investments.
Early Career
In your early career you want to build up your wealth through investments as quickly as possible. You also have a long time before retirement giving you ample room to regain any losses in the market. This is the time where you want to allocate the largest percentage of your retirement investments into high growth investments such as stocks. Always make sure to diversity and not put all of your retirement savings into just a few stocks to avoid unnecessary risk.
Mid Career
The middle of your career is when you want to start reducing your risk as to not wipe out a large portion of your retirement savings when you are preparing to retire. This phase is around 7-20 years before you are preparing for retirement. The range is rather large because as with all retirement investing, it depends heavily on your circumstances and we can only give general guidelines and things to consider.
At this point you want to tone down the level of allocation put into high risk and high growth retirement investments such as stocks. It may be tempting to keep a large portion there for the high potential growth, but if a market downturn similar to this recent one hits you at a bad time, you may have to spend more years working to make up those losses or deal with a reduced income or running out of money upon retirement.
Retirement
At this point of your life, you should already have a healthy amount of retirement savings due to your smart retirement investing. The goal at this point is to protect the money you have from loss and also from inflation. It is not enough to just put it into a bank account because your retirement savings will be chewed up by the average inflation rate of 3% per year.
To meet this goal you want to have a portfolio more heavily allocated to retirement investments that will hold your wealth steady. This means less in stock and more in bonds and indexed mutual funds.
Withdrawal Strategies
Upon retirement you will have your nest egg of retirement savings, but what is the best way to make it last? The general rule based on studies is that withdrawing 4% of the total each year and increasing the percentage with inflation is likely to net about 30 years of income from your savings. We can't predict how long we will live so this step can be very difficult because if you live longer than expected you may run out of funds.
Additionally, if you are hedging against inflation in your account, there will still be upturns and downturns in the market. Not enough to wipe out your retirement savings but there will be fluctuations. To compensate, you can withdraw more of your retirement savings in boom periods and less in bust periods.
Withdrawal from your retirement savings can be further supplemented by other income sources. This could include a small business run by the retiree as a hobby / income source. The retiree can also work a part time job to bring in more money to allow the retirement investments more time to grow.
Conclusion
There are a variety of retirement investments available for the different life circumstances someone may be in. This article gives you an overview of your options and different things to consider when planning your retirement investments. It may be a good idea to hire a professional financial planner to help you assess which retirement investments best fit your life. Make sure this is a legitimate financial planner and they aren't trying to sell you on things you don't need to inflate their commission. The best protection against that is having base knowledge of the different options available yourself to avoid any major pitfalls. Saving for retirement is a very involved process and you should make sure you are putting in the time necessary to pick the best plan for your own retirement investing.
