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Plan Well, Retire Well

Saving and investing your money

Where Should You Invest Your Retirement Plan Savings?


Occasionally I get asked "how do I decide which investments are best for my retirement savings plan?" In turbulent times like these, that's actually a very important question. Through research and personal experience, I have found that there are several factors that need to be considered when choosing investments. Elements such as time horizon, risk tolerance, and market exposure should be carefully considered before investment choices are made.

Time:

Determining how much time you have before your investment will be needed is important in selecting appropriate investment vehicles. The more time you have to invest, the more risk you can take for potentially higher returns. As a general rule, if the money will be needed in the next 5 to 10 years, less volatile investments such as bonds (or bond funds) will likely fund at least 50% of your retirement portfolio. On the other hand, if you have 25 years or more before you retire, your retirement plan is probably 100% invested in equities. The amount of time you have before the money is needed should always be a deciding factor on where your money is invested.

Risk:

In the world of investing, there are several types of risk. There's market risk, inflation risk, interest rate risk, and most importantly, investor risk tolerance. Risk tolerance addresses the issue of how much risk you are willing to take with any given investment. It is important to evaluate the amount of risk you are willing to take when you decide to invest. If you get really nervous about the ups and downs of the stock market, then you would probably feel uncomfortable investing in individual stocks or sector funds. You would likely feel more at ease in a balanced or income fund that offers a good mix of stocks and bonds. There is a popular saying "the greater the risk, the greater the potential return." However, because taking great risks doesn't automatically guarantee great returns, it is important to know how much risk you are willing to take. To find out the appropriate risk level you are comfortable with take the risk tolerance quiz at MSN Money.

Diversification:

When risk is spread out over several companies or industries, the likelihood of a total crash is lowered significantly. Diversification is an investment strategy in which investor portfolios contain a mixture of various types of stocks, bonds, and other investments in order to reduce the risk of loss. Mutual funds are a popular way for small investors to utilize this strategy for investing. When choosing investments to fund your retirement plan, always look at the top 10 holdings, if you are investing in a mutual fund. Are these holding in different industries? Will the failure of any of these companies indirectly impact the other companies? If the answer to the first question is yes and the second is no, then you may have a diversified investment. There are various types of mutual funds. This month's news release provides an overview of the various types of mutual funds investors have to choose from. Also, check out our Asset Allocation Analyzer to ensure that your portfolio is well diversified.

OTHER FACTORS TO CONSIDER

Performance:

Performance information is readily available for investors to review. However, the disclaimer that will be printed on any prospectus or investment literature will undoubtedly state "past performance does not guarantee future results." In laymen's terms, you are being told that just because the investment performed well in the past doesn't mean it will do well going forward. Most people choose their investments based on past performance. Although past performance can give investors information about a particular investment, knowing the top ten holdings in your mutual fund, for instance, and what's going on in the world around us in many cases can be a better indicator of future performance.

Rating:

Companies such as Morningstar provide research-based rating services on stocks, mutual funds and other types of investments. These rating systems can be helpful in identifying which investments you are more comfortable with. Morningstar uses a 5 star rating system to evaluate investments; 5 stars represent the highest rating and 1 represents the worst.

Inflation:

One of the biggest enemies to our savings is inflation. Inflation is the increase in the cost of goods and services over time. This increase can potentially lower your buying power if your investments are not designed to keep pace with inflation. Savings and money market accounts are usually most affected by inflation due to their lower rates of return; investments with higher returns normally fair better.

Taxation:

As the saying goes "the only thing certain in life are death and taxes." Taxation can turn a great investment into an average investment if proper planning is not done. All the gains and increases on your investments can be quickly eaten away by taxes. Higher income tax filers can especially have a difficult time if they don't have credits and deductions to offset their gains. To reduce taxable earnings, some investors are finding IRAs, Keogh plans (for self-employed persons), annuities and municipal bonds viable alternatives. In an effort to keep current with changing times, many companies now are beginning to offer Roth 401(k) and 403(b) plans. These plans allow after-tax contributions into a company retirement plan. The benefit to this type of investment is that tax-free withdrawals are available if you have participated in the plan for 5 years or more and have reached the age of 59 �?�½. An added bonus is that you do not have to make mandatory distributions as is required with traditional plans. Finally, to encourage taxpayers to participate in some type of retirement program, the IRS offers tax credits to tax filers participating in their company's retirement plan, and deductions to those who establish their own traditional IRA, SEP IRA or Keogh plan. For more information on taxes and retirement plans, visit the IRS and Roth 401(k) websites.

As the market continues to go through its ups and downs as markets always do, it is important for you to remember why you are investing. If your investments are for the long term and you believe that over the long term they are solid investments, then you should ride out the wave. As we always remind you, rebalancing your portfolio is always an option. If you need to redistribute current and/or future contributions, then do it with care. Where should you invest? No one has a crystal ball to look into the future. However, watching trends, keeping in mind your time horizon, knowing how much risk you are willing to take, and thinking about your future goals can give you a good idea of which investments will work best for your lifestyle. Until we talk again...



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