While most people receive Social Security, a secure financial retirement depends on also having significant savings in a retirement account. Typically these funds must last nearly 25 years (assuming the average age for retirement is 63 years and the average life expectancy for someone who reaches that age is 19.1 years for a man and 21.8 years for a woman). Many of us now live beyond this life expectancy, so the amount of funds accumulated in retirement accounts depends not only on what you contribute during your work life (and how well those investments did), but on your investment returns after you retire. These in turn depend on your investment strategies.
A Coordinated Approach
If you have more than one retirement account, such as a 401(k) at work and a personal IRA, it’s essential to coordinate your investment strategies across all your holdings. Without coordination you may be duplicating your holdings and not taking full advantage of the opportunity to diversify. And if you’re married, you may want to coordinate investment choices with those made for your spouse’s retirement accounts.
You also want to coordinate your holdings in your taxable and tax-deferred accounts. So if, in addition to your retirement accounts, you have a taxable investment portfolio at a brokerage firm or with a mutual fund, review your holdings in all such accounts. This enables you to put investments in the appropriate accounts, depending on tax considerations (explained later) and other factors. For example, if you want to own tax-free municipal bonds, these belong in your taxable account. If you put them in your tax-deferred retirement account, the interest on the bonds effectively becomes taxable because all of your distributions are taxed as ordinary income, regardless of the source of the earnings.
Factors in Making Investment Choices
There’s no single strategy that’s right for all individuals. Many factors come into play in choosing investments for retirement plans. Consider:
- Your savings horizon. The longer you have until your expected retirement the more risk you can afford to take. The stock market has experienced severe downs, but if you have years to go before you need the funds, you can weather the downs and expect to see the value of your account not only return to its pre-decline level but to an even higher level over time. For example, the stock market hit a low of 6,443.27 on March 6, 2009, causing many accounts to see declines of 20% or more. But if you didn’t sell and your savings remained until now, with the market at nearly 25,000, your account could have quadrupled.
- Your risk tolerance. If you lose sleep at night when the stock market declines, your risk tolerance is low. This means you should invest in securities that are not impacted (or at least not impacted severely) by market swings. That means weighting your investments more heavily with bond funds and U.S. Treasury bonds and other similar securities.
- Taxes. Retirement accounts are either tax-deferred vehicles (e.g., 401(k)s and traditional IRAs), where tax on income is deferred until distributions are taken, or tax-free vehicles (e.g., designated Roth accounts and Roth IRAs), where distributions from the account become tax-free after five years and other conditions are met. Thus, it makes sense to choose investments with taxes in mind. For example, you don’t pay capital gains on stock appreciation or on stock dividends, so you can park your capital gains stocks in your tax-advantaged retirement accounts. By the same token, recognize that even in tax-advantaged accounts you may have current income subject to tax (e.g., Schedule K-1 income from a master limited partnership), which is something you may want to avoid.
- Inflation. Inflation has been relatively mild over the past several years, but with rising Federal interest rates and a tightening job market triggering higher wages, inflation could heat up. Because of this, it is essential to keep a diversified portfolio and not to be exclusively or even predominantly in bond funds or other investments that are adversely impacted by inflation. What does this mean? As inflation pushes interest rates higher, the value of an investment in a bond fund declines.
- Investment fees and costs. Some investments have higher fees than others. Certificates of deposit (CDs) don’t have fees, but there are fees for investments in mutual funds, annuities and various other types of investments. Compare the fees and consider them to be one factor in your investment strategy. (See also: A Guide to Investor Fees.)
If you are in an employer-sponsored plan, you are offered a menu of benefits. For example, the average 401(k) plan offers 25 investment options. It’s up to you to select the type of investment(s) suitable to your situation.
IRA restrictions. The law bars investments in certain types of assets, including:
- Collectibles. If you invest in any of the following, it’s considered a distribution to you: artworks, rugs, antiques, metals, gems, stamps, coins, alcoholic beverages and certain other tangible personal property. However, not treated as collectibles are one, one-half, one-quarter, or one-tenth ounce U.S. gold coins, or one-ounce silver coins minted by the Treasury Department as well as certain platinum coins and certain gold, silver, palladium and platinum bullion.
- Certain real estate. There’s no bar to investing in real estate, but there are various restrictions that make direct investments in realty impractical for most people. (If you want to do it nonetheless, you need to use a self-directed IRA where the trustee can hold the realty for the account). You can, of course, hold real estate through a real estate investment trust (REIT). (For more on doing this, see Key Tips for Investing in REITs.)
The Bottom Line
In most cases, investment strategies are up to you. To make good choices for your personal situation, take advantage of investment advice that may be offered by your employer or the mutual fund hosting your account. Continue to educate yourself about how various investments work. And most important, continually monitor your account so you can shift investment strategies when appropriate (e.g., you're nearing retirement).