Is investing in your retirement fund part of your financial plan? Many of us put money in our savings accounts, invest in a 401(k) at work, and/or have an individual retirement account (IRA) that we contribute to for retirement. These options are valuable, but they may not generate enough money to comfortably cover your ideal retirement lifestyle. To achieve your long-term financial goals, consider adding some strategic investing to your financial plan.
There is a big difference between saving and investing. When you save, you are putting your money into a safe, interest-earning account that is guaranteed by the United States government. Savings accounts, money market accounts, and even IRAs are insured by the Federal Deposit Insurance Corporation (FDIC). (Note: To calculate your deposit insurance coverage, check the FDIC website.) However, the interest earnings on savings accounts, money market accounts, and IRAs are modest at best. The average interest rate for a savings account is 0.09 percent, and the interest rate on a certificate of deposit (CD) is around 3 percent. An IRA will accumulate interest faster than a savings account, but will it be enough to retire?
Investments are riskier, but they offer a higher reward over time. Investing in stocks, bonds, and mutual funds can give you about 12 percent returns on average, but the money is not insured. If you or your investment advisor make a wrong decision, you could lose money. However, if you commit to investments for a longer period, they historically yield higher returns, much higher than you will get from an IRA.
However, you don’t want to pin all your hopes on investments. As part of your financial planning, you need to create a balanced retirement portfolio that includes IRAs, CDs, 501(k) savings, and investments. Your investments should be diversified, as well, including stocks and mutual funds, depending on your tolerance for risk.
If retirement is still many years away, it will pay to establish a diversified retirement plan that includes safe savings, such as IRAs, and investments that should yield higher rewards with more risk. With investment strategies, however, patience is the key to success.
What’s Your Risk Tolerance?
To be successful at investing, you need to have specific goals. Identify the goals you want to achieve with your investments and then plan accordingly.
If you are investing for retirement, that is truly a lifelong goal, and you will have different investment strategies at different stages of your life. How you invest will depend on the number of years until retirement, changes in income, and your appetite for risk. You may also want to invest for shorter-term goals, such as buying a new car or financing your child’s education. With short-term goals, choose investments that are more likely to yield the returns you want in the available time frame.
Once you establish a goal, estimate the total amount you will need to reach it. For example, if you’re saving for your child’s future tuition costs, your goal could be to have $50,000 saved within 10 years. Be sure to add in a buffer for lower-than-anticipated market performance. You then can work with your investment advisor to determine how to diversify your investments.
The Life Stages of Investing
Part of the reason that investments are a lifelong financial strategy is because your financial needs will not remain static. Your goals, risk tolerance, and the amount of time you have to achieve those goals will change, especially if you are using investments as part of a retirement strategy. Here are some considerations for investing at different stages of your life:
- The beginning of your career is the time to get into the habit of saving. Between the ages of 18-25, you will start to earn a regular salary, so you can budget expenses. Start a cash reserve by opening a savings account. As your savings grow, you can move money into IRAs or CDs. This is a conservative savings strategy to start building your nest egg.
- Between the ages of 26-35 is usually when you start to establish a more solid financial foundation. Your income will increase and you might start to make major life changes, such as getting married or starting a family. This is when you start to increase your retirement fund and turn some of those savings into investments. At these ages, most people have not yet achieved their peak earning power and they want to maximize their investments, so they tend to have a higher tolerance for investment risk in order to yield higher returns.
- From around age 36 to age 60, your life will likely change again, and you will have additional financial responsibilities such as paying the mortgage on a home, saving for a child’s college tuition, and caring for your family. During these years, most investors use a more balanced approach for growth, choosing higher-risk, high-yield investments but balancing them with more conservative funds and bonds that are more likely to ensure a return.
- By the time you reach age 60, you will want to think about liquidating your holdings and living on the proceeds. At this stage of your life, your risk tolerance will be lower, and you will want to convert investments into holdings that will yield returns but that also can be converted to cash to supplement social security. This is the time when people choose more stable investments with an eye toward using the money themselves or leaving it to their heirs.
Saving money should become a lifelong habit, and using some of those savings for investments is a great strategy for growing your money. The longer you leave the money invested, the more you will earn. Think of investing as part of long-term financial planning to meet long-term goals.
As you develop your investment strategy, assess your tolerance for risk. Knowing your tolerance for risk and factoring in your age, life phase, and current progress toward your goals will help you determine the right mix of stocks, bonds, mutual funds, and other investments,
To start adding investments to your financial planning, consult with a licensed financial advisor who understands the market and has experience managing retirement portfolios. You can start with a small investment and watch your personal wealth grow as you continue to add to your portfolio and make investing part of your lifelong financial strategy.