“Tell me and I forget, teach me and I remember, involve me and I learn.” Benjamin Franklin
The past several columns taught readers the importance of assessing their financial health and urged them to get involved by suggesting several actionable steps. By learning to create a simple budget, readers were asked to identify amounts available for savings and to establish three “savings buckets.”
The first two buckets included an emergency savings amount and debt repayment amounts. The third recommendation to allocate savings for retirement is more complex, so last month’s column clarified the specific differences and benefits of various types of retirement accounts.
The action for February was to learn more by going online to evaluate the tools offered by a retirement plan provider or by visiting Morningstar.com to review this excellent resource’s retirement planning sections.
While the buckets of savings for emergencies and debt repayment should not be invested to incur any risk to principal, retirement plan monies should be invested with a goal of growing the principal balance over long periods of time.
A retirement savings bucket investment strategy should reflect its “time horizon.” Time horizon refers to the period during which investments are held until they are needed. A simple way to assess your time horizon is to determine the year in which you plan (or want) to retire.
A common age used in the past coincided with when social security benefits were expected to begin at age 65. However, the system established that age in 1940 and since then has been adjusted to begin at 67 for those born after 1960. An action for March is to determine at what age you would like to retire and thus determine your specific time horizon.
When considering an investing strategy for your retirement savings, focusing on a time horizon will help assess your “risk tolerance” which refers to the amount of loss an investor is prepared to handle when making an investment decision. The major factor to help determine the level of risk an investor can afford to take is time.
For younger readers, monies set aside for retirement are meant to be invested for many decades, so the risk tolerance of these balances is very high. For older readers, retirement balances must last for many decades to support living expenses, therefore the investment strategy should also be more aggressive than other savings buckets.
The investment strategy of retirement assets is a critically important component of reaching your retirement goals. Because investing is extremely complicated and requires great resources that most individuals lack, most retirement plans and brokerage firms offer a simple solution: target date funds.
Target date funds are a class of mutual funds that periodically rebalances asset class weights to optimize risk and returns for a predetermined time frame. The asset allocation of a target-date fund is typically designed to gradually shift to a more conservative profile to minimize risk to the principal balance as the target date approaches.
By selecting from a range of funds offered closest to the year in which you plan to retire, for example 2040, the selection of a Target Date 2040 fund is invested by professionals who automatically determine time horizon and risk tolerance. Industry leaders include T. Rowe Price, Vanguard, American Funds and Fidelity.
Action item for March: Investigate the asset allocation and investment returns of the target date funds offered by your retirement plan or brokerage firm.
Next month: What are the differences between mutual funds, index funds and exchange traded funds?
Beth Stegner Peabody is CEO of Stegner Investment Associates, Inc., and a graduate of Sacred Heart Academy.