According to the AARP Public Policy Institute, older African Americans and Hispanics are less likely than whites to have income from pensions and other retirement savings or assets and are more likely than older whites to depend on Social Security for 90% or more of their family income. The study reported that about 10% of African Americans surveyed had an IRA and 45% lack any pension coverage or retirement savings. Social Security was intended to provide vital basic protections for workers and their families, however, savings, pensions, or retirement accounts such as your employee sponsored 401(k) plan are important components of overall retirement income security. But once you have a 401(k) how do you maintain it? Asset allocation or balancing risk and reward based on your retirement timeline is vital to getting the most out of your portfolio.
Here are some things to consider when creating your asset allocation strategy:
Portfolio Goals: Choosing your investments involves creating an investment portfolio that is well diversified (a mix of different types of investment options)—stocks, bonds, and cash. Diversification minimizes risk and maximizes potential return. The process of determining your mix of assets to hold in your portfolio depends on your time horizon and your tolerance for risk.
Time Horizon: Your time horizon is based on the number of years you will be investing until retirement. “If you start in your 20’s you’ll earn more income and gains over your careers,” says Bob Carlson, editor of the monthly newsletter, Retirement Watch . “At retirement your portfolio will be a small percentage of the money you put in—60% or more will come from investment markets.” Here is an example to bolster Carlson’s point: A 25-year-old who contributes 10% of their paycheck (making $35,000 per year) will have $942,433 at retirement (age 65) assuming they get a 7% annual rate of return and the employer matches 50%. Now plug in those same numbers for a 30 year old at the same salary and rates. Although this person only started contributing five years later, they will retire with 652,586, nearly $289,847 less. Point is: time matters, so start now.
Risk Tolerance: Tolerance will vary based on your age, financial goals, income etc. A younger investor is more likely to be an aggressive investor—one who has a higher risk tolerance, because they have a longer time frame to make up for any losses incurred by the economy. In contrast, a 50-year-old will be more conservative (lower-risk tolerance) in choosing their asset allocation because they have a shorter time to make up for losses. You can do an online search to access risk tolerance questionnaires or visit Bankrate’s asset allocation calculator to help you determine what type of investor you are.
For more information on how your 401(k) works check out last weeks post.