David here, your Certified Remote Financial Planner. Using technology to make financial advice available to you, on your schedule and wherever you may be.
Today we are continuing our discussion on investing and focusing in on how to choose the investments in your retirement account. If you have a 401(k) or a 403(b) I hope you are contributing to your account, if not, be sure to check out my prior post “5 Reason to Contribute To Your Employer-Sponsored Retirement Account”. Today’s post goes right along behind that one and answers the question, “Alright, I’m contributing… now what?” To give you that answer I’ve got three easy steps for you to follow.
The first step is to decide how much time you want to commit to managing the investments in your retirement account. Most plans offer three categories of funds for you to choose from: target date, allocation and individual funds. Each one of these categories involves a different time commitment on your part and different fees.
So let’s talk about each one. Individual funds. You’ve heard of these, they are commonly referred to as mutual funds or exchange traded funds (ETFs). They come in all shapes and sizes, but in a nut shell are a collection of individual stocks and bonds. Using individual funds in your retirement account requires the most time initially and ongoing maintenance because of rebalancing, but is the least expensive option.
Allocation funds, are the second category, they handle the rebalancing for you. They are a collection of a few individual funds that are usually organized around targeting a specific level of risk. Using allocation funds in your retirement account requires less work on your part than individual funds, because they do the rebalancing for you, but cost more. Your still not fully out of the woods with allocation funds, they do require some ongoing work and should be reviewed every year. This is to make sure you are still invested in the right risk level based on your time horizon. You may start in a high risk allocation fund, but need to move down to less risky options as you near retirement.
Target date funds are your third option, and take care of this shortful of allocation funds for you because they automatically reduce their investment risk over time. They are as close to set and forget as you can get. These funds do all the work for you but you’ll pay for it in fees.
So that’s step 1, deciding how much time you want to commit. Step two is making sure your investments are diversified. Diversification means that you own a variety of investments that are not 100% correlated. Some are going up, while others are going down. Some are in favor, while others are not. With proper diversity can increase returns of your retirement account while reducing the volatility (ups and downs).
So how do you make sure you’re diversified? Well there are 7 key asset class that you should include in your portfolio to get broad diversification. A diversity of U.S. company stocks, meaning small, medium and large companies in all industries. International stocks of both developed countries, like Europe and Japan and emerging economies like India and China and finally bonds both here in the U.S. and internationally. Those 7 asset classes provide great diversity of investments.
The third step, for choosing the investments in your retirement account is to review the fees. You’re not going to find any funds that don’t have a fee, that’s the price for convenience, but the fees do vary wildly. Individual funds could have fees that are less than a 10th of a percent. While target date funds could come in above 1%, with allocation funds falling in between. 1% may not sound like much of a fee but it can be a huge drag on investment performance. In the post I provide an example on how a 1% fee could decrease your retirement savings by 25% over 30 years! 25% less money! I know some of you are reconsidering step one now. Saving money is good, but if you choose individual funds, and treat them like a target date fund it could cost you a lot more! Weight your options and make an educated decision that’s right for you.
Check out the post for more details on all this and to make sure you’re always up to date with the best financial advice, subscribe to this youtube channel, my weekly blog or schedule a Free 30 minute one-on-one call with me, your Certified Remote Financial Planner. Using technology to make financial advice available to you, on your schedule and wherever you may be.