Anxiety about retirement is high — and rises with every shudder in the financial markets. Americans are increasingly worried that they won’t have enough money to carry them through their lifetime. They’re looking for advice on how to invest their savings to meet that goal. ¶ Most of them are investing in mutual funds. More than half the assets in retirement plans managed by individuals — think IRAs, 401(k)s and 403(b)s — are invested in mutual funds, according to the Investment Company Institute. ¶ Here are eight tips to help you manage your fund investments to keep your retirement savings on track.
The single most effective way to boost your retirement account is to put more money in it. And because the federal government offers substantial tax incentives for retirement savings, saving more helps you reduce your tax bill at the same time.
You’ll take full advantage of these tax benefits if you contribute $16,500 to your 401(k) or $5,000 to your IRA in the 2011 tax year. (The limits are even higher if you’re 50 or older.) But those amounts might be more than you can afford given your other financial needs.
Nevertheless, we strongly recommend you contribute enough to your workplace plan to qualify for any matching contribution from your employer – such as a 50 percent match to your contributions of up to 4 percent of your annual salary. Although the matching contribution is free money for employees, many don’t put enough into their accounts to receive it.
Haven’t made a contribution to your retirement account because you can’t decide between a traditional retirement account and Roth accounts? Don’t agonize. Just pick one and make the maximum contribution.
Both traditional and Roth retirement savings accounts offer tax benefits — they just provide them at different times. In traditional retirement accounts, contributions aren’t taxed, but withdrawals are. The opposite is true for Roth accounts; contributions are taxed, but withdrawals aren’t.
Which type of account is better for you depends on a number of factors, including your tax rate now, your tax rate when you retire, your investment return and how long you will continue to work — factors that are difficult to predict. So don’t pass up on retirement contributions because you’re not sure whether a traditional or Roth is best for you. There is no right answer, so make a reasonable judgment call and start a retirement account.
Settle on a general approach to managing the mutual funds in your portfolio. If you’re comfortable with investing, you might want to go the do-it-yourself route — making your own asset-allocation decisions and picking out your own set of mutual funds. If you’re more comfortable delegating investment decision-making to someone else, you can opt for a one-fund solution — a target-date fund or a balanced fund. (More on those shortly.)
If you choose to put together your own portfolio of funds, take a close look at your allocation to international investments. Odds are that U.S. stocks and bonds make up the bulk of your portfolio, even though U.S. securities now account for less than half of the value of world markets. Today, much of the strongest economic growth — and the highest potential returns — is outside the United States.
Favoring local investments, a phenomenon that academics have dubbed the “home-country bias,” might feel natural, but it reinforces the geographic concentration of your assets. If most of your fund assets, as well as your house and job, are in the United States, you have a lot riding on one country. Your retirement account is one of the easiest ways to diversify away from U.S. securities and the U.S. dollar.
If you prefer a one-fund solution, choose that fund carefully. Many workplace retirement plans, such as 401(k)s, have default options that automatically direct your contributions into a diversified fund that invests in a mix of stocks and bonds. Often that’s a target-date fund designed for your age group. These funds gradually reduce the allocation to stocks as you approach retirement age.
Target-date funds are one-size-fits-all solutions — which means they could well be too tight or loose for you. If you’re particularly risk-averse, for example, a target-date fund might invest too heavily in stocks for your taste. Or you might want more exposure to stocks than a target-date fund offers.
Another one-fund option is to invest in a balanced fund. These funds invest roughly 60 percent of their assets in stocks and the remainder in bonds at all times.
By contrast, the ever-changing asset allocation of target-date funds makes their performance difficult to predict. Many target-date investors were surprised by the losses their funds suffered during the credit crisis of 2008. Some learned too late that their fund was more exposed to the stock market than they had expected. Others mistakenly believed that a target-date fund fully protected their savings from losses.
Regardless of your investment approach, you’ll need to periodically review your portfolio to ensure that it still matches your evolving goals and risk profile. This is particularly important in the 10 to 15 years before retirement.
We strongly recommend that, at around age 50 or 55, you meet with a financial adviser to make sure your savings and investments are on track. You should also discuss how your portfolio decisions fit in with your long-term wishes for gifts or bequests.
Figuring out your financial objectives for the rest of your life is challenging but necessary work. Check with your employer to see whether your retirement plan will pay for a meeting with an adviser.
You need a full picture of how much your mutual funds and other investments cost you. Fund expenses fall into four main categories:
Sales charges: Fees called front-end loads are charged when you make an investment, and back-end loads are charged when you make a withdrawal. You can often avoid paying these loads by buying products or fund classes specially designed for retirement investors.
Advice fees: 12b-1 fees are annual charges by mutual funds that are deducted from fund assets. Fees charged by brokers, financial planners and investment advisers are usually levied outside the fund as a percentage of account assets.
Investment-management fees: The fund manager charges these as a percentage of your assets under management. These are typically highest for stock funds and lowest for money-market funds, with bond funds in the middle.
Account fees: These come in many forms, such as annual maintenance fees on individual retirement accounts and administrative fees on 401(k) and other workplace retirement accounts. (Plans must disclose these charges to participants beginning in 2012).
There are no hard and fast rules for the “right” level of fees, as they vary by the size and type of account, the investments selected and the services provided. But whatever your circumstances, be sure to ask about all these fees and do your comparison shopping.
How you handle withdrawals from your retirement account is just as important as how you save and invest in it. Many 401(k) investors take a lump-sum distribution from their account at retirement. This results in a large tax payment that can easily be avoided by transferring the assets to an IRA.
After retirement, two investment options can help your assets last as long as possible:
Life annuities: As the name suggests, a life annuity pays you a fixed income throughout your retirement. If you use a portion of your account assets to buy an annuity, you’ll significantly reduce the risk that you’ll outlive your money.
Managed-payout funds: Put your money in a managed-payout fund, and you’ll get professional help converting assets to income at a sustainable rate. These funds aim to provide you with a steady flow of annual payments, though they are not guaranteed.
Pozen is a senior lecturer at Harvard Business School and a senior fellow at the Brookings Institution. Twitter @pozen. Theresa Hamacher, CFA, is president of Nicsa.