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Advancements in medicine and technology are helping us live longer than ever before. But the prospect of living in retirement for up to 40 years — often the same time frame an individual spends working — makes saving and planning all the more important.
Yet saving is only one piece of the retirement puzzle. Choosing the right underlying investments and retirement account are critical to getting the most from your savings. Here’s how to manage that process.
How much should I save?
Many advisors recommend saving 10% to 15% of your income, but some savers may fall outside that target range. If you have doubts on your trajectory, consult our retirement calculator to pressure-test your approach. We are going to assume here that you already have some sense of how much you should be setting aside to reach your retirement goals.
How should I invest?
After establishing how much to save, it’s time to figure out what to invest in. There's a lot to consider when building a retirement portfolio, and we'll take you through some of those details below. But here are some of the most common products investors choose for retirement.
If you’re saving for retirement in your company’s 401(k) or a similar employer plan, it’s worth noting that not all of these investments may be available. But you can gain access to the other types of investments you desire by using different retirement accounts — more on those near the bottom of this page.
An effective and low-maintenance way to maintain an appropriate asset allocation is through a target-date fund. Just pick the right “target date” (the year closest to when you’d like to retire) and the fund company will automatically adjust the allocation over time on your behalf.
Diversification helps investors by decreasing overall investment risk while increasing potential for overall return. Mutual funds, index funds and ETFs all pool investor money into a collection of securities, allowing investors to diversify without having to purchase and manage individual securities.
Mutual funds: For years, most mutual funds have been actively managed by professional fund managers. This means that teams of analysts and portfolio managers research, analyze and select certain stocks that they expect will outperform to be part of their mutual fund. In recent years, passively managed funds, also called index funds, have gained traction for their generally lower costs and ease of ownership.
Index funds: Index funds are a type of mutual fund, but they operate more simply than active funds. There’s no fund manager picking stocks — these funds merely purchase shares of all the securities in an index, such as the S&P 500 — which keeps investors’ costs down. Iconic investors such as Warren Buffett have famously praised index funds, which has helped increase their popularity in recent years.
Exchange-traded funds: ETFs are like mutual funds, but with a key difference. They can be traded throughout the day on exchanges, like individual stocks and bonds. (Mutual funds can only be bought and sold for their prices set at the end of each trading day). ETF share prices are often lower than the minimums required for comparable mutual funds, which allows investors to attain broad exposure for less money.
Individual stocks and bonds
Some investors prefer researching and purchasing shares of individual stocks and bonds. It can take significant investment and know-how to build a diversified portfolio of individual securities, but a case can be made for including individual stocks and bonds as part of your investment strategy. For example, producing a steady stream of income can be compelling as you begin to withdraw money from your investments in retirement. Dividend stocks can provide a regular income stream, and constructing a bond ladder (buying numerous bonds maturing across a number of years) helps to manage interest rate risk while generating steady cash flow.
Some people sleep better at night knowing that all of their base expenses are covered by income streams they cannot outlive. This is where using a portion of your assets to acquire an investment product like an annuity can make sense. Purchasing an annuity shifts the risk of outliving your assets away from you to the insurance company that guarantees to pay you an income stream for life (make sure to review the credit rating of the insurance company). However, annuities can be costly, so buy one with only the features you need. Since variable annuities provide a guaranteed income that can increase with market returns, an investor might want to be more aggressive with the investments inside the annuity and more conservative with those outside the annuity.
Hire an advisor
If you’re wary of handling investment choices on your own, there are many different types of financial advisors to lend you a hand. Hiring a robo-advisor is a low-cost way to access investment help with low or no minimums. Robo-advisors use computer models and algorithms to help customize investments for your portfolio. Here are some of the top picks from our analysis of robo-advisors.
How does this fit into my portfolio?
When selecting investment products, it’s important to keep the big picture in mind. Take into consideration your goals, risk tolerance and time horizon, or the length of time you have to invest prior to reaching your goal. Together, these factors point you to the optimal asset allocation for your total investment portfolio. If you have multiple investment accounts, you'll want to consider them all when evaluating your asset allocation.
Retirement accounts generally should be the most aggressive part of your overall investment portfolio because these accounts usually have the longest time horizon. Additionally, in some accounts like a 401(k), you smooth your entry point into the markets over time through dollar-cost averaging. Retirement accounts are also a great place to be active or trade more frequently. Although we’re not advocating active trading, if you do need to trade, doing so in your tax-deferred retirement account is preferred since there aren’t any capital gains tax consequences. Taxes aren’t paid in traditional IRAs and 401(k)s until withdrawals are made.
“And remember, the asset allocation and underlying investments of your retirement account should not be static.”
To balance a more aggressive allocation within retirement accounts, you can be more conservative within taxable brokerage accounts. Since these accounts would usually be used first to satisfy any shorter-term goals or expenses incurred on the road toward retirement, having a more conservative allocation helps to reduce volatility, avoiding the possibility of the market being down when you need to withdraw funds.
And remember, the asset allocation and underlying investments of your retirement account should not be static. They should gradually change and adjust over time, becoming more conservative as you near the transition into retirement.
Throughout the market cycle, asset classes zig and zag. Sometimes stocks are up and bonds are down, but other times it's the other way around. Diversification minimizes the chance that one asset class derails the entire portfolio, truly demonstrating the old adage "don't put all your eggs in one basket!" You can diversify in many ways:
Active vs. passive. Incorporating mutual funds, which are actively managed, with index funds and ETFs, which are passively managed.
Industry. Mixing companies operating in all kinds of industries because the economic cycle affects each business differently.
Size. Combining holdings of large-cap, mid-cap and small-cap companies (big, medium-size and small companies).
Style. Blending growth and value stocks. Growth stocks are companies characterized by rapidly growing sales and profits. Value stocks are companies whose stocks are “on sale” or seem underpriced and undervalued. With bonds, mix credit quality and maturity dates.
Geography. Sometimes U.S. stocks and bonds outperform, but other times international will prevail, so have exposure to both.
If you’d like more background on how to get started, our Investing 101 guide may help. Again, if this sounds like more upkeep than you’d like to handle, a target-date fund or robo-advisor might be a good option.
Which retirement account should I use?
Now that you’re familiar with some of the most popular types of retirement investments, which retirement accounts should you use? Check out our handy guide on how to save for retirement to figure out the best retirement plan or account(s) for you. Accounts you might choose include:
Employer-sponsored plans, such as 401(k)/403(b)/457(b) and pension plans.
IRAs, traditional or Roth.
Self-employed or small-business plans, such as SEP, SIMPLE, solo 401(k) and profit-sharing plans.