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    August 2013
    M T W T F S S
    « Jul   Sep »


    Investing for Retirement

    Guy Conger

    Making decisions about your retirement account can
    seem overwhelming, especially if you feel unsure
    about your knowledge of investments. However, the
    following basic rules can help you make smarter
    choices regardless of whether you have some
    investing experience or are just getting started.
    Don’t lose ground to inflation
    It’s easy to see how inflation affects gas prices,
    electric bills, and the cost of food; over time, your
    money buys less and less. But what inflation does to
    your investments isn’t always as obvious. Let’s say
    your money is earning 4% and inflation is running
    between 3% and 4% (its historical average). That
    means your investments are earning only 1% at best.
    And that’s not counting any other costs; even in a
    tax-deferred retirement account such as a 401(k),
    you’ll eventually owe taxes on that money. Unless
    your retirement portfolio at least keeps pace with
    inflation, you could actually be losing money without
    even realizing it.
    What does that mean for your retirement strategy?
    First, you’ll probably need to contribute more to your
    retirement plan than you think. What seems like a
    healthy sum now will seem smaller and smaller over
    time; at a 3% annual inflation rate, something that
    costs $100 today would cost $181 in 20 years. That
    means you’ll probably need a bigger retirement nest
    egg than you anticipated. And don’t forget that people
    are living much longer now than they used to. You
    might need your retirement savings to last a lot longer
    than you expect, and inflation is likely to continue
    increasing prices over that time. Consider increasing
    your 401(k) contribution each year by at least enough
    to overcome the effects of inflation.
    Second, you need to consider investing at least a
    portion of your retirement plan in investments that can
    help keep inflation from silently eating away at the
    purchasing power of your savings. Cash equivalents
    may be relatively safe, but they are the most likely to
    lose purchasing power to inflation over time. Even if
    you consider yourself a conservative investor,
    remember that stocks historically have provided
    higher long-term total returns than cash equivalents
    or bonds, even though they also involve greater risk
    of volatility and potential loss.
    Invest based on your time horizon
    Your time horizon is investment-speak for the amount
    of time you have left until you plan to use the money
    you’re investing. Why is your time horizon important?
    Because it can affect how well your portfolio can
    handle the ups and downs of the financial markets.
    Someone who was planning to retire in 2008 and was
    heavily invested in the stock market faced different
    challenges from the financial crisis than someone
    who was investing for a retirement that was many
    years away, because the person nearing retirement
    had fewer years left to let their portfolio recover from
    the downturn.
    If you have a long time horizon, you may be able to
    invest a greater percentage of your money in
    something that could experience more dramatic price
    changes but that might also have greater potential for
    long-term growth. Though past performance doesn’t
    guarantee future results, the long-term direction of the
    stock market has historically been up despite its
    frequent and sometimes massive fluctuations.
    Think long-term for goals that are many years away
    and invest accordingly. The longer you stay with a
    diversified portfolio of investments, the more likely
    you are to be able to ride out market downturns and
    improve your opportunities for gain.
    Consider your risk tolerance
    Another key factor in your retirement investing
    decisions is your risk tolerance–basically, how well
    you can handle a possible investment loss. There are
    two aspects to risk tolerance. The first is your
    financial ability to survive a loss. If you expect to need
    your money soon–for example, if you plan to begin
    using your retirement savings in the next year or
    so–those needs reduce your ability to withstand even
    a small loss. However, if you’re investing for the long
    term, don’t expect to need the money immediately, or
    have other assets to rely on in an emergency, your
    risk tolerance may be higher.
    The second aspect of risk tolerance is your emotional
    ability to withstand the possibility of loss. If you’re
    invested in a way that doesn’t let you sleep at night,
    you may need to consider reducing the amount of risk
    in your portfolio. Many people think they’re
    comfortable with risk, only to find out when the market
    takes a turn for the worse that they’re actually a lot
    less risk-tolerant than they thought. Often that means
    they wind up selling in a panic when prices are
    lowest. Try to be honest about how you might react to
    a market downturn, and plan accordingly.
    Remember that there are many ways to manage risk.
    For example, understanding the potential risks and
    rewards of each of your investments and its role in
    your portfolio may help you gauge your emotional risk
    tolerance more accurately. Also, having money
    deducted from your paycheck and put into your
    retirement plan helps spread your risk over time. By
    investing regularly, you reduce the chance of
    investing a large sum just before the market takes a
    Integrate retirement with your other
    financial goals
    Make sure you have an emergency fund; it can help
    you avoid needing to tap your retirement savings
    before you had planned to. Generally, if you withdraw
    money from your retirement plan before you turn
    59½, you’ll owe not only the amount of federal and
    state income tax on that money, but also a 10%
    federal penalty (and possibly a state penalty as well).
    There are exceptions to the penalty for premature
    distributions from a 401(k) (for example, having a
    qualifying disability or withdrawing money after
    leaving your employer after you turn 55). However,
    having a separate emergency fund can help you
    avoid an early distribution and allow your retirement
    money to stay invested.
    If you have outstanding debt, you’ll need to weigh the
    benefits of saving for retirement versus paying off that
    debt as soon as possible. If the interest rate you’re
    paying is high, you might benefit from paying off at
    least part of your debt first. If you’re contemplating
    borrowing from or making a withdrawal from your
    workplace savings account, make sure you
    investigate using other financing options first, such as
    loans from banks, credit unions, friends, or family. If
    your employer matches your contributions, don’t
    forget to factor into your calculations the loss of that
    matching money if you choose to focus on paying off
    debt. You’ll be giving up what is essentially free
    money if you don’t at least contribute enough to get
    the employer match.
    Don’t put all your eggs in one basket
    Diversifying your retirement savings across many
    different types of investments can help you manage
    the ups and downs of your portfolio. Different types of
    investments may face different types of risk. For
    example, when most people think of risk, they think of
    market risk–the possibility that an investment will lose
    value because of a general decline in financial
    markets. However, there are many other types of risk.
    Bonds face default or credit risk (the risk that a bond
    issuer will not be able to pay the interest owed on its
    bonds, or repay the principal borrowed). Bonds also
    face interest rate risk, because bond prices generally
    fall when interest rates rise. International investors
    may face currency risk if exchange rates between
    U.S. and foreign currencies affect the value of a
    foreign investment. Political risk is created by
    legislative actions (or the lack of them).
    These are only a few of the various types of risk.
    However, one investment may respond to the same
    set of circumstances very differently than another,
    and thus involve different risks. Putting your money
    into many different securities, as a mutual fund does,
    is one way to spread your risk. Another is to invest in
    several different types of investments–for example,
    stocks, bonds, and cash alternatives. Spreading your
    portfolio over several different types of investments
    can help you manage the types and level of risk you
    Participating in your retirement plan is probably more
    important than any individual investing decision you’ll
    make. Keep it simple, stick with it, and time will be
    your best ally

    The MONEY® Network