IN SOME WAYS, the most crucial retirement investing advice we can offer is also the simplest: Start early, max out your 401(k) and save as much in other tax-advantaged accounts as you can.
If you do that much — even half that much — you'll be light years ahead of most Americans.
The fact is, tax-free compounding is a blessing from Uncle Sam that you can't afford to waste (see The Magic of Retirement Accounts). And if your company is willing to give you money in the form of a match, by all means take it — every penny of it. You'll never get a better return anywhere else.
Important piece of retirement wisdom No. 2: While you don't have to be an investment genius to get your money right, the more you know about investing, the better you'll do. That's another way of saying that most of this site — not just this section — is devoted to teaching you how to pick investments. If you haven't already, visit Investing 101. It'll give you the background you need to make the most of your retirement savings.
Allocating Your Assets
OK, let's get down to business. We'll talk about specific investments on the next page. But the first step in putting your retirement money to work is to create a reliable asset-allocation plan. Whether you're 25 or 75 years old, your portfolio needs a mix of investments — stocks, bonds and cash — to provide the proper balance between risk and growth. Some studies show that proper allocation can have more impact on your returns over time than the individual investments you choose (see Asset Allocation: Why it Works for more).
A lot of advice givers suggest you set up an allocation specifically for your retirement accounts. And your company's plan has probably provided you with allocation guidelines based on your age (75% stocks/25% bonds, 50% stocks/50% bonds, and so on). If retirement assets make up all of your savings, then there's nothing wrong with using those guidelines and getting started. But as your portfolio grows and becomes more complicated — retirement assets, college-tuition assets, taxable savings — our view is that you should wrap everything into one allocation plan. Our Guerrilla Funk Asset Allocation section will show you how to do it.
Unfortunately, all the rules and regulations surrounding retirement accounts make things a bit tricky sometimes. Here are some things you need to think about when setting up an allocation in a 401(k) plan or IRA.
Picking Investments
Investment selection in a 401(k) plan can presents a special problem, since your options are often so limited. If all your savings are in your 401(k) and it doesn't offer a solid small-cap or international fund, for instance, you'll probably have a hard time satisfying your ideal asset mix.
So you just have to do the best you can.
Say you're a 35-year-old man with medium tolerance for risk whose suggested allocation is this: 31% large-cap stocks, 25% small caps, 19% international stocks, 10% fixed income and 15% cash. Say also that your 401(k) offers an S&P Index fund, a solid bond fund, a money-market fund and company stock.
Our advice would be to put 10% of your money into the bond fund and the rest into the index. Then, as you accumulate savings outside your 401(k) — either in an IRA or a taxable account — you can start to satisfy your overall allocation with that money. The money-market fund, of course, would satisfy your cash allocation, but we wouldn't recommend doing that. Since you're young and you may need to access your cash for other things (a house down payment, for instance, or some sort of emergency), those funds should be kept outside your 401(k) (see the table below for more on which asset types are best suited to retirement accounts).
An IRA gives you a lot more flexibility than a 401(k) since you can generally pick whatever investments you like. But there are still certain types of assets that work better in retirement accounts than others.
For instance, investments that come with high tax liability are best held in your tax-advantaged retirement accounts. These include everything from dividend-paying large-cap stocks to aggressive mutual funds with high turnover (since a fund manager who churns his portfolio can create a big tax bill for the fund's investors). The table below will help you sort things out.
