Cash in envelope labeled '401k'


Retirement accounts are not a one-size-fits-all solution that you can set up and ignore until age 65. Sadly, many employees accept the default investment mix for their company's 401(k) account and then compound that error by letting their savings sit in those same funds until they retire. As a result, their nest egg doesn't grow large enough to support them in retirement. Fortunately, giving your retirement account a little TLC now and then can go a long way toward helping your money last as long as you do.

Let's go over some basic suggestions for someone who plans to retire at or around age 65 and is moderately risk-tolerant. If that doesn't describe you to a "T," then you can adjust them as you see fit.

The ABCs of retirement accounts

Risk management is a crucial part of any investment strategy -- especially your retirement plan. Some types of investments, such as small-cap stocks, are quite risky but offer a high potential return. Other investments, such as government bonds, are extremely safe but only achieve small returns, sometimes even lagging the inflation rate. Risky investments tend to gain and lose value in big swings, but they also tend to return more over time than their more stable brethren.

For 401(k)s and other retirement accounts, the rule of thumb is that the closer you are to retirement, the less risky your investments should be. Early in your career, you should put more of your money into riskier assets like stocks, because if they experience a sudden drop in value, you'll still have plenty of time to let your investments recover before you'll need to start selling them off for income -- and you'll be able to take advantage of their greater rate of return. As a group, stocks tend to be riskier than bonds, but their historical rate of return has been far higher.

The old formula for deciding how to allocate retirement funds was to subtract your age from 100 and invest the remaining percentage of your money in stocks, with the rest going into bonds. Using this formula, a 20-year old employee would invest 80% of his money in stocks and 20% in bonds. Unfortunately, that system no longer works so well, because people are living longer these days. Most investors should lean more heavily on stocks and hold them longer to ensure they'll have a well-funded retirement. A better guideline for most people is to subtract their age from 110 and invest the resulting percentage in stocks.

Graph trending upwards


Early days: Age 25-35

If you're wise enough to start saving this early in your career, then you'll have a huge advantage! The magic of compound interest will help you make the most of every penny you invest now. You have plenty of time to go before retirement, so 100% of your money should go into stock funds. Index funds are a great choice, since they generally have much lower fees than actively managed funds, and they also tend to outperform other funds over the long haul. A good all-purpose investment mix at this point would be 40% in a small-cap index fund (preferably a value fund), 25% in a large-cap index fund, 25% in a mid-cap index fund, and 10% in the international fund of your choice.

Moving up: Age 35-45

As your career advances, you will hopefully be able to increase your 401(k) or IRA contributions. This will also help you reduce your tax liability, given that retirement contributions typically come out of your pre-tax income. You're somewhat closer to retirement now, so you should shift 20% of your contributions into bonds or other fixed-income investments. Your stock allocations can also shift a bit into less volatile territory. Of the 80% you will be leaving in stocks, a potential mix could be 30% in small-cap index funds, 35% in large-cap index funds, 25% in mid-cap index funds, and 10% in international funds.

At your peak: Age 45-55

Assuming you plan to retire on or after your 65th birthday, you still have at least 10 years to go. Now is the time to really max out your contributions. Think of it as a retirement insurance premium, and those contributions will help ensure you have the golden years you want. This is also a good time to move a bit more of your money into bonds. Bump your allocation to around 60% stocks and 40% bonds. Of the money you still have invested in stocks, you might shift your funds to 40% in large-cap index funds, 25% in either small- or mid-cap index funds (depending on your tolerance for risk), another 25% in mid-cap index funds, and the final 10% in international investments.

Getting there: Age 55-60

As you approach retirement age, you'll want to keep a closer eye on your investments. This is definitely the point where you should look for investments that don't have much volatility. And since you're getting pretty close to the point where you'll be using that money, your rate of return is less important. You should split your investments roughly 50-50 between stocks and bonds. The stock investments should be skewed toward funds that won't give you a lot of sleepless nights. Of the remaining money that you have invested in stocks, consider putting 70% in large-cap index funds, 10% in small- or mid-cap index funds, 10% in mid-cap index funds (preferably growth funds), and 10% in international investments. You may also want to shift those international investments into more stable regions.

Crossing the finish line


Home stretch: Age 60-65

Retirement is getting pretty close, so your investments should start moving into their final positions. This is where you'll want to maintain them during your retirement years, assuming you don't immediately liquidate your investments to buy that yacht you've been dreaming about. Starting at age 61, you'll want to shift your stock investments into bonds at a rate of 5% per year until you reach age 65 and retirement. Then you'll have 75% of your money invested in bonds and only 25% still in stocks. Those stock funds can stay a the same allocation of roughly 70% large-cap, 10% small- or mid-cap, 10% mid-cap, and 10% international.

If you're feeling nervous, you might want to shift more of your stock holdings into large-cap growth funds, which tend to be fairly stable even in difficult market conditions. Resist the urge to put all your savings into supposedly guaranteed investments like bonds, because your portfolio will need a growth component to help keep it from being eroded by inflation.

Fine-tuning your investment mix

Choose your investments wisely, and you'll be able to enjoy the fruits of your labor for many years. Once a year, right around your birthday, take a few minutes to look over your retirement accounts and confirm that the investments are performing as expected. If a particular fund hasn't been doing as well as you'd like, consider switching to another fund in the same asset class that can give you a better return for your money.

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