What should I know about investing for retirement?
Perhaps the most difficult part of saving for retirement is understanding how to invest. By learning the basics, like types of investments and how to choose them, you can set yourself up for success.
You’re not just saving, but investing
When you contribute money to a retirement account, like a 401(k) or IRA, you’re investing in assets designed to help your money grow. Because you’re saving for the long haul, the investment options are particularly suited for long-term saving. Investments in your retirement plan often carry some risk, but over time have the potential to be rewarding.
The most popular investment option
The most popular investments available in retirement accounts are stocks, bonds and cash equivalents, and these are most often offered as mutual funds. A mutual fund typically contains lots of underlying investments, like stocks, and combines them into one investment. You and many other investors own shares of the fund, and share in its gains and losses.
Your choice: risk vs. reward
Investments like mutual funds don’t promise a rate of return. Their value is determined by markets and the success and failure of underlying investments. The potential of loss adds a factor of risk to mutual funds.
However, with risk can come reward. Markets and underlying investments have the potential to significantly rise in value, and subsequently reward the value of your account.
Ultimately, how you invest is your choice. You may want to play things conservatively and stick to low-risk investments, or be more aggressive for the chance of greater returns. Many people find that a healthy balance of various investments is the most prudent way to save.
The value of diversification
Because various investments tend to react differently to the same market conditions, it’s wise to keep investments diversified. This simply means spreading your savings out among investments with different risk levels. Putting your money in mutual funds can help with diversification. Spreading your money out further in different types of mutual funds (stocks and bonds) can help even more.
The importance of asset allocation
Asset allocation is how you diversify your investment mix. Properly allocating your retirement assets helps you establish a risk level you’re comfortable with, while potentially minimizing risk and increasing rewards. When choosing an asset allocation, consider the following:
- Your goals – Are you hoping to see large gains in your plan or are you looking to preserve your retirement funds?
- Your time horizon – How long will you invest before you begin taking withdrawals?
- Your risk tolerance – Are you comfortable with investments that may fluctuate in value?
If you aren't sure how to set your allocation, don't worry. There are many tools available that can help you establish an appropriate mix.
Don’t forget fees
Remember that investments have fees, and the most common one is the expense ratio. This is the fee paid to the investment company for managing the fund. Expense ratios vary from low to high, and can impact your returns. When choosing a fund to invest in, consider the expense ratio as part of your decision.
Review your investment mix annually
It's important that you review your investment choices at least annually. You may need to adjust your asset allocation as you get closer to retirement or if you find that your risk tolerance has changed. Your investments can grow at different rates, so you also may need to shift your investments to realign with your original asset allocation strategy.
The bottom line
You don’t have to be an investment expert to experience gains in your retirement assets. By understanding investment types, risk versus reward, diversification and asset allocation, you can now select investments with more confidence.