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Retirement Advice for My Friends & Peers

A few friends asked me how they should invest their retirement money recently. Maybe it’s that time of year. Graduations inevitably lead to new jobs, which lead to new retirement plans.

Plus, the roiling markets are making a lot of people nervous. One friend confided that she just moved all of her retirement savings into bonds. Yikes. Not a good idea.

So, in the spirit of friendship, I’ve put together some simple guidelines about how to set up a retirement plan, specifically for those who still have more than 30 years left in the work force.*

Savings. Make sure you’re saving enough. Boulevard R and investment firms like Vanguard offer tools that calculate how much you’ll need to save today to meet your retirement goals. At the very least, put enough away to get your full employer match (it’s free money!) If you can’t possibly do that much, then just save something. The money has years and years to grow.

Asset Allocation. The most important part of managing an investment portfolio is choosing the right mix of stock and bond funds. If retirement is at least 30 years away, you should consider investing more than 85% of your portfolio in stock funds. The remaining portion can be invested in high-quality bond funds and cash (like money market accounts). Historically, stocks have performed better than bonds over long periods of time. But they’ve also gone through bigger upswings and downswings. As such, the stock side of your portfolio will help ensure your money keeps growing, while the bond portion should deliver more consistent, predictable returns when the stock market is down.

While putting 85% in stocks is a good starting point, the precise amount you invest in stocks should also depend on your tolerance for risk. Can you refrain from selling everything if the market takes a bit hit? The more you have in stock funds, the more your portfolio will swing – for better and for worse.

Vanguard’s Target Retirement 2035 Fund, 2040 Fund, 2045 Fund and 2050 Fund – which invest in a mix of stocks and bonds for people planning to retire in those years – all have about 90% invested in stocks. A fellow FiLifer, Tara, tried out a 100% allocation. (Remember, you’ll increase your bond portion as retirement nears).

Diversification. After you figure out your stock and bond split, you’ll need to think about how to diversify the stock portion of your portfolio. Different pieces of the markets do well at different times. Keep these points in mind:

1. A well diversified portfolio invests around the world. My personal portfolio is invested 50% in non-U.S. funds and 50% in U.S. funds. Some people like to keep more money in the domestic markets than I do, but don’t skimp. Most financial planners would agree that keeping at least 20% of your portfolio in international funds is a good idea.
2. You want exposure to different sized companies, including large-cap stocks, mid-cap stocks, and small-cap stocks. The bulk of most expertly-managed U.S. stock portfolios are invested in large-caps. This makes sense because large-cap stocks compose the majority of the U.S. stock market. For example, the Russell 3000 Index, which tracks the total U.S. stock market consists of about 66% large cap stocks, 26% mid cap stocks, and 8% small cap stocks. It’s reasonable to make your portfolio reflect this breakout. It might be easier to just invest in a total stock market or “All-Cap” fund.
3. A well-rounded portfolio invests in both growth stocks and value stocks. Many institutional investors put 50% of their U.S. stock allocation in growth funds and 50% in value funds. A broad-based fund, like a S&P 500 index fund, invests in both.
4. Some retirement plans offer the option of investing in real estate, commodities, and other niche areas. These sector funds can provide great diversification and have the potential to outperform other stock funds, but they can be risky and often carry high fees.

Fund performance and fees. Use index funds whenever possible. There is little proof that active managers, who charge higher fees and try to beat the markets, actually perform better than index funds over long periods of time.

Patience. The markets go up and down. Just ride it out. Inevitably, some of your allocations will grow and others will shrink as certain parts of the market do better than others. To keep things in line, check your portfolio and rebalance your allocations back to their original amounts once or twice a year. Resist the temptation to dip into your savings via a 401k loan.

If you have more specific questions, or pieces of advice, please feel free to post them in the comment section.

– Kristen Sullivan

* These guidelines should put you on the right track. Keep in mind that an independent financial planner can provide you personalized advice.

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