As employer pensions go the way of the dodo, the responsibility for investing retirement funds is being dropped onto the shoulders of individual workers. Of course, not everyone is comfortable with the idea of betting his future on his ability to pick the right investments. If you know nothing about investing and don't care to learn, but want to be sure that your retirement savings will be sufficient unto the day, consider adopting one of the following strategies.
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Target date funds
The target date fund is a fairly new retirement investing option. The concept is simple: you decide roughly when you plan to retire, then pick a target date fund that matches that year. For example, if you plan to retire sometime around the year 2035, you'd look for a target date fund with the year 2035 in its name. Once you find the right fund, all you need to do is deposit your contributions and the fund manager will take care of the rest: picking your investments, shifting the allocations as you age to less risky investments, rebalancing investments to keep your chosen allocations between types of investments, and so on.
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Index funds and ETFs
If you don't have access to a target date fund or prefer a bit more control over your retirement investments, then an index fund or ETF is the way to go. These investments seek to track the performance of a particular stock or bond index so that as the index climbs or falls, so will the fund. Index funds have several advantages over traditional, actively managed funds: there is no need for a high-priced investment expert to pick the fund's investments, since the index does it for them; transactions are typically far lower in an index fund, meaning you pay a lot less in transaction fees; and because index funds inherently use a buy and hold strategy rather than a timing strategy, they tend to outperform actively managed funds.
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Stocks versus bonds
If you choose an index fund or ETF rather than a target date fund, you'll have one extra decision to make: how much you want to invest in stocks versus bonds. For retirement investments, the accepted approach is to subtract your age from 110 and put that percentage of your investments in stocks, with the remainder in bonds. For example, if you're 40 years old, you'd subtract 40 from 110 and get a result of 70. That tells you that you need to put 70% of your investments in stocks and the other 30% in bonds. Now you can simply buy one stock index fund and one bond index fund and allocate your contributions according to the above formula.
Adjusting your allocations
As the above formula implies, you'll need to adjust your percentage of stock and bond investments as you get older. You'll also need to reallocate as your balances shift over time thanks to the performance of your investments (unless you have a target date fund; this is something your fund would do for you).
For example, let's say you chose to put 70% of your contributions in stocks and the other 30% in bonds. The stock market prospered during the following year, while bonds dropped in value. If you come back and look at your investments one year later, you'd probably find that your allocations had shifted due to the performance of those stock and bond markets: you might now find that your retirement savings account has 74% of its value in stocks and 26% in bonds. Thus, in order to keep your retirement investments balanced correctly, you'll need to go back once a year and readjust your holdings.
In the above example, you'd sell some of your stocks and use the funds to buy more bonds. This would also be a great time to shift your allocations according to the 110 minus your age formula. Since you'd probably gotten a year older during last year, you'd want to shift your balances to 69% stocks and 31% bonds.
Getting the returns you want
If you've done your retirement homework, you have a pretty good idea of how much money you need to have to fund the retirement you want and therefore how much of a return you need to get on your retirement contributions. That's something else you'll want to review at the time you do your annual reallocating. If your contribution rate is based on the idea that your retirement investments will earn an 8% annual return and you realize that over the last few years, your investments have only earned 6%, you should consider changing funds.
One factor that can have considerable impact on your returns is fees: these can vary widely between different funds and ETFs, so compare the fees before choosing a fund -- and check them again every year to make sure they haven't shot up in the meantime.
Note that over short spans of time, the stock market can fluctuate dramatically, so don't base your performance concerns just on the fund's returns. Rather, compare your fund's performance to the performance of the market as a whole. If your fund has been significantly underperforming the market for the past few years, it's definitely time to consider a change.
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