Presented by: Matthew A. Clayson
Saving for retirement is better than spending every dollar you earn, but just putting money aside probably won’t get you where you want to be. That’s why investing may be a crucial component of any retirement plan. It takes the money you earn from work and allows it to go to work for you.
A successful retirement investment strategy often touches on the following principles:
- Start early
- Invest more aggressively to start
- Diversify investment risk
- Keep fees low
- Transition into safer investments over time
Whether you’re investing on your own through an IRA, through your employer with a 401(k), or both, here’s what you need to know about laying out an investment strategy that will hopefully get you from where you are now to a comfortable retirement.
Start early with your retirement investment plan
If you’re earning income from a job, you can open a traditional or Roth IRA. Minors can start saving through a custodial account that a parent has control over until they turn 18 or 21, depending on the type of plan and what state they live in.
Let’s say that when you’re 25, you start saving for retirement by investing $100/month and assume a moderate average annual return of 5 percent. By the time you’re 55, you’ll have about $80,000.
If you don’t start saving for retirement until you’re 35, you’ll have to invest $200/month to earn the same amount by age 55 at the same return. If you only invest $100 a month, you’ll have to earn an 11 percent rate of return to end up with the same amount by age 55.
Invest more aggressively to start
It’s important not to panic and change your investment strategy if this happens, experts note. Rather, it may be a great time to stay invested and invest more so you can follow the adage “buy low, sell high.”
In other words, when stocks plummet, you can likely buy them on the cheap. Over time, assuming the market rebounds, you’ll have the opportunity to experience investment growth that people who withdrew from their investments missed out on.
But just because an investment entails risk doesn’t mean it will pay off. The type of risk you want to take is a calculated, time-tested one. Over more than a century, betting on the U.S. economy by investing in the stock and bond markets has proven rewarding. However, putting all of your money into a single company, no matter how well it appears to be doing, is the type of risk many people don’t want to take.
Diversify investment risk
All investing carries risk: You might lose money. Investments are not guaranteed to increase in value and are not FDIC insured.
Not investing also carries risk: Your money may lose value to inflation over time, and without putting your money to work through stock and bond markets or other financial vehicles, it can be challenging to accumulate enough for retirement.
Mutual funds provide an easy way to invest in a professionally managed portfolio consisting of dozens or even hundreds or stocks, bonds, and other securities. Mutual funds can be a great choice for people who don’t have the time, interest, or know-how to invest in individual stocks and bonds.
Exchange-traded funds, or ETFs, and index funds are similar to mutual funds in many ways, but they usually aim to copy the performance of a market index, such as the S&P 500® Index. Owning shares of mutual funds or ETFs is a little like having an investment manager working for you who requires little of your time or money.
Keep investment fees low when saving for retirement
Almost all investments have fees. For mutual funds, you might pay a commission to buy or sell a fund, an ongoing fee called an expense ratio for the fund’s management, or a sales charge. For ETFs, you’ll pay an expense ratio and possibly a commission.
ETFs are usually passively managed, meaning you’ll pay a lower expense ratio to own them; mutual funds can be actively or passively managed.
Why are fees so important? In the same way that investment returns compound over time, the effect of fees on your portfolio compounds over time. The higher your fees, the less money you have to invest, and the lower your net returns tend to be. Further, investments with higher fees have no guarantee of outperforming investments with lower fees. That’s why it’s important to do your research or hire a trusted professional to do it for you.
Transition into safer investments over time when saving for retirement
It’s important to take enough risk to meet your goals while maintaining enough safety to feel comfortable. As you get closer to retirement age, you have less time to recover from a market downturn, which means you need more safety and less risk in your portfolio.
Most savings accounts don’t pay enough interest for your nest egg to support you through several decades of retirement. Investing in a careful, risk-managed way can allow you to outpace inflation and multiply your savings over the years.
Don’t want to go it alone? A financial professional can help you create a plan for your retirement.