When people manage their retirement accounts, whether it is a company-sponsored 401K plan or a personal Individual Retirement Account (IRA), there tends to be much uncertainty about what to do. Frequently, there is a tendency for investors to either be too aggressive or overly risk averse. A young adult with the bulk of his or her investments in a money market account or bonds is being too conservative.
Company plans will normally have some type of choice among different stock alternatives along with investments in bonds and a money market account. If one works for a publicly traded company, that person can normally invest in the company’s stock. This is far riskier than investing in a diversified stock portfolio. Many people have become wealthy from their company stock, but others have seen their retirement plans decimated, in addition to losing their jobs from a corporation that did poorly. Having a modest portion invested in one’s company is reasonable, but it shouldn’t be the majority of one’s assets.
The next risky category would be smaller company stocks, along with emerging markets. Not all plans may offer these options, but if they do, it would be risky to have a majority of holdings in these funds. Clearly, smaller company stocks and emerging markets offer the best potential for longer-term growth and are appropriate for most portfolios, except for conservative ones. Generally, if these investments are being used, they should be no more than 10% to 20% of a portfolio.
The most important consideration is asset allocation, or a mix among different investment options. For people in their 20s and 30s, having at least 60% in stocks is appropriate. For young adults with a fair tolerance for risk, their mix in stocks could actually approach 100%. The portfolio should be well-diversified, with at least a significant portion in a large company fund, such as the S&P 500. Having a portion invested internationally is also recommended.
For middle-aged and older investors, investment in stocks should be reduced over time. However, for people in their 60s, life expectancy is still generally at least 20 years, so having a moderate amount in stocks, such as 40% to 60% may still be reasonable.
The temptation for many is to alter their normal investment mix depending upon market circumstances. Few investors can consistently time the market, knowing the appropriate time to sell, and more importantly, when to get back in. This is not to imply that changes shouldn’t be made, but are normally best made on a gradual basis. For example, small stocks have performed significantly better than large stocks over the past 10 years, so moving additional money to large companies would be appropriate now.
Managing a retirement account requires a disciplined approach, first, in recognizing that gyrations will occur and, second, in realizing that longer-term significant growth should be sought.