Few people set money aside and invest on a regular basis just because they enjoy the process. The vast majority do it to get ahead and to accumulate a nest egg for retirement. You can invest for retirement like a pro if you know where to invest, what to invest in and how to invest. Here we cover all three.
The best place to invest for retirement is in your 401k or similar plan at work if one is available to you. The money you set aside is deducted from your paycheck automatically, so you avoid the temptation of spending it. Some employers match what you contribute, and this is free money. Plus, in traditional 401k plans you can get a tax deduction each year you make contributions.
The next best alternative is to open a traditional or Roth IRA. Both offer tax incentives that are advantageous to accumulating a retirement nest egg. If you want to set aside additional money after you max out your 401k and/or IRA, consider a tax-deferred annuity that offers both fixed and variable investment options (a combination or variable annuity).
Now we address what to invest in. All three of the above have something in common. You can invest in stocks, bonds, and other investments that are professionally managed for you in a 401k, IRA or variable annuity.
In a typical 401k the vast majority of investment options are mutual funds … stock funds and bond funds. If you open an IRA with a major mutual fund family, you should have a broad array of funds to choose from. Variable annuities offer funds (called sub-accounts) as well.
By investing in mutual funds you can diversify and maintain a balanced portfolio just like the pros do. In fact, you have professional money managers selecting stocks, bonds and other investments for you.
Mutual funds are the best way to invest for retirement for most people because the task of selecting specific stocks, bond issues etc. is performed by professionals for the investor at a modest cost.
How to invest becomes much simpler when investing in mutual funds. You need only to select a handful of funds from the following categories to achieve diversification and a balanced retirement investment portfolio: stock funds, bond funds, money market funds and/or balanced funds.
The art of investing or how to invest then comes down to asset allocation. What percent of your assets should you invest in each of the four categories above? This will depend on your risk tolerance, whether you want to be aggressive, moderate or conservative.
For example, moderate or middle-of-the-road investors might want 50% of the cash contributions flowing into their retirement plan going to stock funds with the rest split between bond funds and a money market fund. Or simpler yet, such an investor might allocate 75% to a balanced fund labeled as “moderate”, which invests in both stocks and bonds. The other 25% would be allocated to a money market fund for safety.
Now, there is one more crucial step to investing for retirement. Let’s say that you decide to invest with 75% of your money going into a moderate balanced fund like a lifecycle fund, and 25% going to a money market fund. Once a year or so you will want to REBALANCE your assets to keep your asset allocation close to your 75% – 25% asset allocation target.
For example, if you see that your balanced fund assets represent 80% vs. 20% in your money market fund, move some money from the balanced fund to the money market fund to get back to 75% – 25%.
These basic guidelines should help you stay on track when investing for retirement, and should moderate your overall risk while producing good average long-term returns.