Years ago, retirement-focused investors would have likely put their money in a balanced mutual fund, which typically consists of 60% equities and 40% bonds. While that asset mix is still popular among savers today – you get some growth from stocks and some protection from bonds – investors now have more choice.
Here’s a look at some of the more popular investment options:
Stocks for growth
The majority of savers still buy stocks – either directly or through a mutual fund or exchange-traded fund – which are shares in a publicly listed company. Stock prices tend to rise over the long-term, which is why people buy them. Since 1926, the S&P 500 has posted a 10.24% average annual return with dividends reinvested, according to S&P Dow Jones Indices. In other words, if you invest in equities in your 30s and retire in your 70s, there’s a high likelihood that your money will have grown over those 40 years.
The downside is that stocks can fall. In the Great Recession of 2008 and the more recent pandemic stock market plunge, stock prices dropped by more than 35%, which caused a lot of problems for those in and nearing retirement.
Fortunately, while all stocks fluctuate in price, there are a lot of different kinds to choose from depending on your risk tolerance level. If you’re a more aggressive investor you might tilt a stock portfolio to sectors with higher growth potential, but also more volatility, such as technology, while more conservative investors might focus on blue-chip companies in sectors such as financials, consumer staples or industrials, where there traditionally has been less potential for the biggest gains, but also less volatility. But all stocks carry risk of losses and volatility profiles have been changing in recent years. The best way to limit exposure to stock volatility is investing through diversified equity funds rather than single-stocks or narrow sector investments.
Bonds for safety
Bonds are another popular investment for savers as they can move a lot less in price than stocks. Investors lend money to a government or company in exchange for an annual payment based on a predetermined interest rate. At the end of that bond’s term – usually between one and 30 years – you get back your original investment. Investors like bonds for two reasons: they get some guaranteed annual income and there’s less risk, depending on the kind of bond you buy, of losing any money. Because of this, bonds tend to fluctuate less than stocks and so they balance out a portfolio’s overall ups and downs.
Bonds aren’t perfect, however. First of all, there are different kinds of bonds with different risk levels. Generally, Treasury bonds, which are fixed income securities issued by the federal government, have little risk of defaulting. Even with America’s high debt load, they’re going to pay the interest on their loans. The same can’t be said for certain municipalities, which also raise money through bond issues, or companies that may be in financial trouble. If an issuer defaults, your bond could be worthless.
As well, these days interest rates are so low that you can barely earn any money from holding fixed income. Also, when bond yields rise, prices drop and vice versa. If you need to sell your bond before the maturity date and yields climb, you’ll have to sell it for a lower price than you bought it for. There’s something else: Most individuals don’t hold actual bonds — they tend to own bond funds, which hold a number of fixed income instruments, as buying a single bond is difficult for the average person to do. That fund’s value could fluctuate depending on where interest rates go. With rates so low, many people think that at some point interest will have to rise which could negatively impact the price of your bonds. Still, if you’re worried about the stock market at all, then bonds will usually help smooth out the ups and downs.
Alternative asset classes
There are many other investments to choose from and most experts recommend holding about 5% to 10% of assets in things other than stocks or bonds. Gold is a popular investment because the yellow metal’s price tends to rise during recessions and in big market declines. Depending on your level of sophistication, you can also purchase other kinds of commodities, like oil or silver, or dabble in futures and options. It’s a good idea to talk to a professional before making any outside-the-box investment decisions.
What funds should you buy?
There are a variety of funds types to consider when saving for retirement. Golden Years Forever presents you the most popular options.
Actively managed mutual funds
These funds have been around for decades and are still the most-popular kind of security among retail investors. They hold a variety of stocks or bonds, and sometimes both, in one investment vehicle. Mutual funds are ideal for people who don’t want to choose their own stocks. Instead, a professional fund manager can do it for you. If you want to own a bunch of international stocks, but don’t want to pick individual companies, then buy an international stock fund. The same goes for tech stocks, U.S. stocks and corporate bonds – there’s a fund for everything. The main drawbacks are fees and flexibility. Because someone else is doing the stock picking, fees are higher on actively managed mutual funds than on other kinds of investment vehicles. You also can’t buy or sell them during the day as they’re only priced after the market closes.
Index funds
Index funds are similar to active mutual funds, except there’s no stock picker. These funds track a benchmark index, like the S&P 500 or the broad-based MSCI World Index. One of the issues with traditional mutual funds is that most don’t beat their benchmarks especially when you factor in the higher fees. Index funds were developed to avoid underperformance – returns are the same as the index they follow. There is a management fee, but it’s a lot less than what you might find on a traditional mutual fund. Like active mutual funds, you can’t sell them during the day and they only get prices after the trading day is over.
Exchange-traded funds
ETFs are like traditional mutual funds in that they hold a basket of securities, like stocks or bonds, and they’re like index funds in that many track a benchmark. They’re different, though, in that they trade on a stock exchange, which means they’re priced in real-time and can be bought and sold at any point during the day. That’s less important for retirement investors who hold stocks for the long-term, but still, you never know when you might need to sell something. Most importantly, index ETFs are cheap. Many come with no management expense fees, while others have fees between 2 basis points and 10 basis points (0.02% and 0.10%). That’s why they have seen their popularity soar – as you’ll see later on, the more you can save on fees, the more money you can put towards your retirement.
Target date funds
One of the most popular investments these days are target date funds, which are a class of all-in-one mutual funds or ETFs that adjust their asset class mix automatically as you age. For instance, someone who’s in their 30s in 2022 might hold a 2060 target date fund, which, right now, might hold 90% stocks and 10% bonds. As you age, the stock and bond mix will self-adjust. Once the fund reaches its target date, the allocation shifts to a 50/50 portfolio – so in the year 2060, this target date fund’s allocation will consist of 50% stocks and 50% bonds. The allocation will continue to shift toward bonds for approximately seven years after the designated date
By becoming more conservative, there’s less of a chance of losing money in the market in the few years leading up to retirement. In many employer-sponsored retirement plans, target date funds are now the default investment choice if investors don’t actively make investment selections.
Build your portfolio
A lot of people like investing on their own, but when it comes to retirement savings it’s a good idea to work with a financial advisor who has a certified financial planning designation. Here are a few things to look for in a good advisor.
• Qualifications: CFP is the most widely recognized financial advisor designation.
• Services they provide: Do they specialize in retirement planning? Can they help you create a budget? Do they sell all kinds of securities?
• Compensation: Some advisors get paid by the mutual fund companies they invest your money with, others charge an upfront fee or an hourly rate for help. The latter are usually called fee-only planners and some people think they’re more objective, since they’re not getting paid by anyone else but you.
• Track record: Ask to speak to references. You don’t need your advisor to provide stellar returns, but rather you want to make sure they’re attentive, understand your needs, can create solid plans and know how to help you invest.
• Communication: People tend to panic when the markets get bad and when their advisor doesn’t’ reach out to tell them to stay calm. Find out how often your advisor wants to meet and how they’ll be in touch. You don’t need to handholding, but you do want to meet with them at least a couple of times a year.
One of the first conversations you’ll have with an advisor is around your time horizon and risk tolerance levels, which are two key things to consider when building a portfolio.
Most advisors tell their clients to get more conservative as they get older because there’s less time to recover from a drop. That doesn’t mean you need to hold more bonds than stocks, but if you had, say, an 80% stock and a 20% bond mix, then you may want to be closer to 50-50 come retirement. This is a rule of thumb, though many people reach retirement with a big nest egg and still can keep a good portion of their assets in stocks. Just make sure that any money you need for day-to-day living is not subject to market ups and downs.
Think about fees
It’s important to assess fund management and trading fees since they can eat into profits. Even do-it-yourself investors typically have to pay commissions on some trades. Here’s an example: If you invest Rs.800000 in a fund with a 2% fee, and if you assume a 5% rate of return over 30 years, you’ll end up paying approx Rs.1500000 in fees. If you pay 0.5 % in fees, which is possible to do, you will fork over approx Rs.500000. That’s a big difference.
Active mutual funds tend to be more expensive than index funds and exchange-traded funds, which, in most cases, passively track a market index like the S&P 500. Fees on active funds have come down due to the pressure from index funds and ETFs. According to the Investment Company Institute, the average equity mutual fund fee is now roughly 0.5%. But most index ETFs and index mutual funds remain cheaper — a few ETFs even launched in recent years with no fees at all. There’s a major movement towards lower-fee investments, in general, even if not zero-fee, so expect more funds to drop their prices in the coming years, and some active mutual fund companies are starting to launch their own active ETFs as well.