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 individual retirement account (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. (Related: Custodial accounts and Coverdells: How to use them)
“The sooner you start saving, the sooner you begin to receive compound interest,” pointed out Jared Weitz, a veteran of the financial services industry and founder of United Capital Source, which provides funding to small businesses and entrepreneurs. When you invest early on, you can earn interest on the original sums you invest and on the interest that investment generates.
“Young professionals worry about saving enough, become overwhelmed, and then put nothing away,” Weitz said. “But even if you start saving small amounts, the compounding interest will be in your favor over the long haul when compared to someone who starts later and puts large sums of money away.”
Let’s say that when you’re 25, you start investing $100 per month. We’ll assume a moderate average annual return of 5 percent. By the time you’re 55, you’ll have about $80,000. (Learn more: Why saving for retirement early is important)
If you don’t start until you’re 35, you’ll have to invest $200 a month to earn the same amount by age 55 at the same rate of return. And if you only invest $100 a month, you’ll have to earn an 11 percent rate of return to end up with the same nest egg by age 55. Such a high rate of return may not be achievable and would require taking on more risk than is advisable for most people.
Weitz also recommended saving a percentage of your salary, not a dollar amount, so that as your salary rises, your savings increase, too.
Invest more aggressively to start
“Over the course of your working years, you have one major thing on your side and that’s time,” said Kyle Whipple, partner and financial professional with C. Curtis Financial Group in Plymouth, Michigan. “If you experience a large market crash, you have time to recover.”
And 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. (Learn more: Why identifying your risk profile is essential to investing)
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 and who want to reduce their portfolio’s volatility through diversification. (Related: Mutual fund and ETF basics)
Mutual funds have different objectives and risk levels. One might be designed to preserve capital and take on minimal risk, so it might invest in U.S. government bonds. Another might be designed to invest in up-and-coming companies with the hope of earning market-beating returns. Whatever your investment goals, you can probably find mutual funds designed to help achieve them.
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. Many investors who want help selecting investments and creating a plan specific to their situation work with a financial professional. (Recommended: Two types of investment professional: Which is right for you?)
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 called a load. For ETFs, you’ll pay an expense ratio and possibly a commission. Stock trades might come with commissions when you buy and sell, but don’t have ongoing fees. Bond prices may be marked up when you buy and marked down when you sell.
ETFs are usually passively managed, meaning you’ll pay a lower expense ratio to own them; mutual funds can be actively or passively managed, and active management tends to cost more. By comparing similar funds to each other, you can see if those with higher costs appear to be worthwhile given their potential returns. Keep in mind that past performance is no guarantee of future results.
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. Fees don’t just take away from the money you have today; they take away from what you could have potentially earned in the future if you had more principal invested. 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
It’s important to take enough risk to meet your investing goals while maintaining enough safety to feel comfortable. And 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.
One way to gradually adjust your investment mix from more aggressive to more conservative as you approach your goal retirement age is with a target date fund. It’s as simple as buying a fund whose name contains the year you plan to retire. The fund managers will automatically adjust its asset allocation from more aggressive to more conservative as the fund’s target date approaches.
You aren’t going to withdraw your entire retirement portfolio balance the day you turn 65, and a good target date fund will reflect that by not becoming too conservative on its goal date. While you’ll want to be able to withdraw a small percentage of your portfolio, perhaps 3–5 percent, each year, you also need to remain invested for the long term since your retirement may stretch out for 20 to 30 years or longer.
Because they aren’t personalized, however, target date funds are not the right choice for everyone. Whipple said he prefers his clients to have more control over how their portfolios are set up. (Related: The ideal retirement portfolio withdrawal rate)
“There may be times that, although a client is not going to retire for a while, we may want to stay more conservative,” he noted. “That being said, target date funds take the guesswork out of investing for people who do things on their own or have no intention of working with an advisor or asset manager.”
It doesn’t have to be an either-or choice, however. You can put some of your retirement money into a target date fund and invest some on your own or with the help of a financial professional.
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 MassMutual financial professional can help you create a plan for your retirement.
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This article was originally published in May 2019. It has been updated.