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Investing Your Retirement
Money -- Part VI
Opening a retirement account (IRA, 401(k) etc.) is only half the battle. How you manage the money you save is just as important as the type of retirement account you set up. Following the right investment strategy can put the money you've saved to work so it can grow for you and your family, and provide the financial security you are looking for.
Different investment strategies will result in different returns. The following sections will help you figure out which investments are right for you. In general, when we think about investing, we need to consider three important variables that will impact your investment strategy:
- Time
- Risk
- Diversification
Let's look at each now.
A. Time
Time should have an important effect on your investment strategy. Investing for longer periods of time enables you to wait out short market fluctuations, and reap the rewards of possible longer-term market gains.
Also, as time passes and you earn money on your investments, you can reinvest those earnings. By reinvesting earnings you will benefit from what is known as compounding or earning "returns on your returns."
For example: Let's say you invest in a bond today that pays you a coupon (a fixed payment that the bond issuer is obligated to pay you) of 10% every 6 months. Well, if the bond cost you $100 and you make $10 after 6 months, you can reinvest that $10 and now you will earn 10% on a $110 investment. So, in six months you will receive $110*10% = $11 rather than the $10 you received last month. That's the benefit of compounding!
How It Works:
Because younger people have a longer period of time until they will need to access their retirement funds, they have time to invest in securities that might fluctuate in value. As they are not retiring in the near future, they have the freedom to hold on to the investments until their value rebounds. The stock market has outperformed the bond market (on average) over the long run. Therefore, it makes sense for women with more than 10 years until retirement to have a higher ratio of riskier investments (more stocks than bonds) in their portfolios than older women.
On the other hand: Older women have less time to hold their investments. For them, retirement will come sooner, and so will their needs for retirement funds. Therefore, the balance in a portfolio for a woman with less than 10 years until retirement should be more heavily weighted towards safer investments. (more bonds than stocks.)
B. Personal Risk
Your personal risk tolerance is another factor when choosing your investment portfolio. Risk is important because the more risk you take with your investments, the higher the potential return can be. Risk and reward . . . you can't have one without the other!
For example: When you go to Las Vegas, a riskier bet has lower odds that you will win. But, if you do win you'll get a greater payoff than you'd get from a lower risk bet. Whether or not risky betting is for you, the same rules work with investing... the higher the risk you take, the higher your possible return.
Investment vehicles run the gamut in terms of risk levels:
- High Risk Investments: speculative stock, aggressive growth funds, emerging market funds, high yield bonds, stock options
- Medium Risk Investments: income funds, stock funds, growth funds, stock, international funds, real estate
- Low Risk Investments: CD's, US treasury bonds, money market funds, balanced funds, equity income funds, blue chip stock
Most women tend to be more conservative than men when it comes to their investments. For example, single women only put 14.6% of savings in equities v. 27.6% for single men. (Bureau of Labor Statistics and The WEFA Group - 1993)
Believe it or not, this can severely damage your prospects for a sound financial future! Fortunately, it's never too late to re-chart your financial path.
We do not mean to suggest that women should pounce on the first risky tip they find, but rather, note that a little risk can go a long way. Think about this: on average, it could take 3 times as long to double your investment in a bond than in a stock.
C. Diversification
In a nutshell: Diversity = Balance
By balancing your portfolio, you can avoid the risks associated with any one type of investment. In other words, if the stock market goes down, you have bonds to rely on to generate a positive return and vice versa.
For example: If it never rains and you sell umbrellas, you will make little money. If it always rains and you sell sunscreen, you will make little money. If you diversify your product line and sell both sunscreen and umbrellas, when will you make money?
Theoretically if you're selling both, umbrellas and sunscreen, you'll ALWAYS make money - whether it's raining or the sun is shining. That's the benefit of diversification! You'll have a financial cushion to reduce your risk because you'll sell umbrellas when it's raining and sunscreen when it's sunny out. And, you are virtually guaranteed a return since there will always (theoretically) be a need for umbrellas or sunscreen.
Summary:
The table below provides general guidelines that will help you to formulate your investment strategy in terms of time, risk, and diversification.
Years to Retirement |
Risk Tolerance |
Time Horizon |
Investment Weighting |
Diversify |
Less than 10 |
Low |
Short |
Bonds |
Yes |
More than 10 |
High |
Long |
Stocks |
Yes |
Updating your portfolio
Choosing a strategy for your retirement account is a start. But remember, each year your portfolio of investments should be reassessed for changes in the current market landscape as well as changes in your personal investment goals.
Investment ideas can come from magazines, newspapers, friends and family, and/or your investment advisor. All ideas should be balanced against time, risk and diversification.
And be confident in your decisions! Women tend to have higher returns on their investments than men do. In fact, women overall earn more than 1.4 percentage points a year more than men do with their investments. (Partially because women pay lower transactions costs since they execute fewer trades.) Single women earn 2.3 percentage points a year more than single men. And, all female investment clubs earned 23.8% average yearly return between 1991 and 1998 v. only 19.2% for all male clubs.
Continue to: Part VII: Annuities
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